[Federal Register Volume 85, Number 105 (Monday, June 1, 2020)]
[Rules and Regulations]
[Pages 32991-33004]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-10291]
[[Page 32991]]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 30
[Docket No. ID OCC-2019-0013]
FEDERAL RESERVE SYSTEM
12 CFR Part 208
[Docket No. OP-1680]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 364
RIN 3064-ZA10
NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Part 741
RIN 3133-AF05
Interagency Policy Statement on Allowances for Credit Losses
AGENCY: Office of the Comptroller of the Currency (OCC), Treasury;
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); and National Credit Union
Administration (NCUA).
ACTION: Final interagency policy statement.
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SUMMARY: The Office of the Comptroller of the Currency, the Board of
Governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, and the National Credit Union Administration
(collectively, the agencies) are issuing an interagency policy
statement on allowances for credit losses (ACLs). The agencies are
issuing this interagency policy statement in response to changes to
U.S. generally accepted accounting principles (GAAP) as promulgated by
the Financial Accounting Standards Board (FASB) in Accounting Standards
Update (ASU) 2016-13, Financial Instruments--Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments and subsequent
amendments issued since June 2016. These updates are codified in
Accounting Standards Codification (ASC) Topic 326, Financial
Instruments--Credit Losses (FASB ASC Topic 326). This interagency
policy statement describes the measurement of expected credit losses
under the current expected credit losses (CECL) methodology and the
accounting for impairment on available-for-sale debt securities in
accordance with FASB ASC Topic 326; the design, documentation, and
validation of expected credit loss estimation processes, including the
internal controls over these processes; the maintenance of appropriate
ACLs; the responsibilities of boards of directors and management; and
examiner reviews of ACLs.
DATES: The interagency policy statement is available on June 1, 2020.
FOR FURTHER INFORMATION CONTACT:
OCC: Amanda Freedle, Senior Accounting Policy Advisor, Office of
the Chief Accountant, (202) 649-6280; or Kevin Korzeniewski, Counsel,
Chief Counsel's Office, (202) 649-5490; or for persons who are hearing
impaired, TTY, (202) 649-5597.
BOARD: Lara Lylozian, Chief Accountant-Supervision, (202) 475-6656;
or Kevin Chiu, Accounting Policy Analyst, (202) 912-4608, Division of
Supervision and Regulation; or David W. Alexander, Senior Counsel,
(202) 452-2877; or Asad Kudiya, Senior Counsel, (202) 475-6358, Legal
Division, Board of Governors of the Federal Reserve System, 20th and C
Streets NW, Washington, DC 20551. For the hearing impaired only,
Telecommunication Device for the Deaf (TDD), (202) 263-4869.
FDIC: Shannon Beattie, Chief, Accounting and Securities Disclosure
Section, (202) 898-3952; or John Rieger, Chief Accountant, (202) 898-
3602; or Andrew Overton, Examination Specialist (Bank Accounting),
(202) 898-8922; Division of Risk Management Supervision; or Michael
Phillips, Counsel, (202) 898-3581, Legal Division, Federal Deposit
Insurance Corporation, 550 17th Street NW, Washington, DC 20429.
NCUA: Technical information: Alison Clark, Chief Accountant, Office
of Examination and Insurance, (703) 518-6611 or Legal information:
Ariel Pereira, Staff Attorney, Office of General Counsel, (703) 548-
2778. National Credit Union Administration, 1775 Duke Street,
Alexandria, VA 22314.
SUPPLEMENTARY INFORMATION:
I. Introduction
On October 17, 2019, the agencies requested comment for 60 days on
a proposed Interagency Policy Statement on Allowances for Credit Losses
\1\ (proposed Policy Statement), which would maintain conformance with
GAAP and FASB ASC Topic 326.
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\1\ 84 FR 55510 (October 17, 2019).
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FASB ASC Topic 326 replaces the incurred loss methodology for
financial assets measured at amortized cost, net investments in leases,
and certain off-balance-sheet credit exposures, and modifies the
accounting for impairment on available-for-sale debt securities. FASB
ASC Topic 326 applies to all banks, savings associations, credit
unions, and financial institution holding companies (collectively,
institutions), regardless of size, that file regulatory reports for
which the reporting requirements conform to GAAP.\2\ The agencies are
maintaining conformance with GAAP and consistency with FASB ASC Topic
326 through the issuance of the final Interagency Policy Statement on
Allowances for Credit Losses (final Policy Statement).\3\
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\2\ See section 37(a) of the Federal Deposit Insurance Act and
section 202(a) of the Federal Credit Union Act. Under these
statutory provisions, the accounting principles applicable to
reports or statements required to be filed by all insured depository
institutions with the Federal banking agencies (OCC, Board, FDIC) or
by all federally insured credit unions with assets of $10 million or
more with the NCUA Board must be uniform and consistent with GAAP.
Furthermore, regardless of asset size, all federally insured credit
unions must comply with GAAP for certain financial reporting
requirements relating to charges for loan losses. See 12 U.S.C.
1831n(a)(2)(A), 12 U.S.C. 1782(a)(6)(C), and 12 CFR 702.402(d).
\3\ If the agencies determine that a particular accounting
principle within GAAP, including a private company accounting
alternative, is inconsistent with the statutorily specified
supervisory objectives, those agencies may prescribe an accounting
principle for regulatory reporting purposes that is no less
stringent than GAAP. In such a situation, an institution would not
be permitted to use that particular private company accounting
alternative or other accounting principle within GAAP for regulatory
reporting purposes.
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The agencies have issued guidelines establishing standards for
safety and soundness, including operational and managerial standards
that address such matters as internal controls and information systems,
an internal audit system, loan documentation, credit underwriting,
asset quality, and earnings that should be appropriate for an
institution's size, complexity, and risk profile.\4\ The principles
described in the final Policy Statement are consistent with these
guidelines.
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\4\ See Appendix A to 12 CFR part 30 (OCC), Appendix D to 12 CFR
part 208 (Board), and Appendix A to 12 CFR part 364 (FDIC), which
were adopted by the banking agencies for depository institutions
pursuant to section 39 of the Federal Deposit Insurance Act. See 12
U.S.C. 1831p-1. Federally insured credit unions should refer to
section 206(b)(1) of the Federal Credit Union Act (12 U.S.C. 1786)
and 12 CFR 741.3.
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The final Policy Statement does not prescribe requirements for
estimating expected credit losses. It describes the measurement of
expected credit losses in accordance with FASB ASC Topic 326; the
design, documentation, and validation of expected credit loss
[[Page 32992]]
estimation processes, including the internal controls over these
processes; the maintenance of appropriate ACLs; the responsibilities of
boards of directors and management; and examiner reviews of ACLs.
The comment period for the proposed Policy Statement ended on
December 16, 2019. The agencies received 23 comment letters from trade
associations, financial institutions, and individuals. Several
commenters raised issues outside of the scope of the proposed Policy
Statement that were not addressed in the final Policy Statement.\5\
General comments on the notice and agency responses are summarized in
Section II. Specific comments on the proposed Policy Statement and
changes to the final Policy Statement the agencies made in response to
these comments are described in Section III. The Paperwork Reduction
Act is addressed in Section IV. Section V presents the final Policy
Statement.
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\5\ For example, the agencies received comments requesting
exemptions from applying FASB ASC Topic 326. Other commenters
requested adjustments to regulatory capital requirements upon
adoption of FASB ASC Topic 326.
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The final Policy Statement becomes applicable to an institution
upon that institution's adoption of FASB ASC Topic 326.\6\ The
following policy statements are no longer effective for an institution
upon its adoption of FASB ASC Topic 326: The December 2006 Interagency
Policy Statement on the Allowance for Loan and Lease Losses; \7\ the
July 2001 Policy Statement on Allowance for Loan and Lease Losses
Methodologies and Documentation for Banks and Savings Institutions; \8\
and the NCUA's May 2002 Interpretive Ruling and Policy Statement 02-3,
Allowance for Loan and Lease Losses Methodologies and Documentation for
Federally Insured Credit Unions \9\ (collectively, ALLL Policy
Statements). The agencies will rescind the ALLL Policy Statements once
FASB ASC Topic 326 is effective for all institutions.
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\6\ As noted in ASU 2019-10, FASB ASC Topic 326 is effective for
fiscal years beginning after December 15, 2019, including interim
periods within those fiscal years, for public business entities that
meet the definition of a Securities Exchange Commission (SEC) filer,
excluding entities eligible to be small reporting companies as
defined by the SEC. FASB ASC Topic 326 is effective for all other
entities for fiscal years beginning after December 15, 2022,
including interim periods within those fiscal years. For all
entities, early application of FASB ASC Topic 326 is permitted as
set forth in ASU 2016-13.
\7\ See Financial Institution Letter (FIL) 105-2006 (FDIC);
Supervision and Regulation (SR) Letter 06-17 (FRB); Accounting
Bulletin 06-01 (NCUA); and Bulletin 2006-47 (OCC). The final Policy
Statement does not affect Attachment 1 to the December 2006
Interagency Policy Statement on the Allowance for Loan and Lease
Losses. Attachment 1 has been revised through a separate interagency
notice published elsewhere in this issue of the Federal Register.
\8\ See FIL-63-2001 (FDIC); SR 01-17 (FRB); and Bulletin 2001-37
(OCC).
\9\ See Interpretive Ruling Policy Statement (IRPS) 02-3.
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II. General Comments on the Proposed Policy Statement
Many commenters expressed support for the proposed Policy
Statement. These commenters noted that the proposal is generally
consistent with FASB ASC Topic 326 and retains the flexibility and
judgmental nature of GAAP. Commenters also stated that supervisory
practices and principles were clearly communicated. Some commenters
appreciated the agencies' statement that examiners generally should
accept an institution's ACL estimates and not seek adjustments to the
ACLs when management has provided adequate support for the loss
estimation process employed, and the ACL balances and the assumptions
used in the ACL estimates are in accordance with GAAP and regulatory
reporting requirements.
A number of commenters requested that the agencies include
information in the final Policy Statement to provide additional
guidance around technical aspects of FASB ASC Topic 326 and reduce the
amount of management judgment required to implement the accounting
standard. For example, commenters requested additional clarity on
segmentation, data availability, estimating expected losses for credit
cards, and accounting for loans transferred between held-for-sale and
held-for investment classifications.
Requests were also made for the agencies to require certain
measurement approaches or methods in places where FASB ASC Topic 326
provides flexibility, such as requiring a single expected credit loss
estimation method, defining the reasonable and supportable forecast
period, providing an economic forecast or a simple model that can be
used by all institutions, and aligning the agencies' long-standing
practice for collateral-dependent loans with the collateral-dependent
practical expedient in FASB ASC Topic 326.\10\
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\10\ The regulatory reporting requirement to apply the
collateral-dependent practical expedient in ASC 326-20-35-5 for
collateral-dependent loans, regardless of whether foreclosure is
probable, was retained by the agencies to achieve safety and
soundness objectives.
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The agencies considered these requests and decided not to limit
flexibility in implementing FASB ASC Topic 326 by narrowing options or
defining terms that are not defined in GAAP. The final Policy Statement
does not endorse a specific loss estimation method or provide more
detail about specific implementation choices, including providing
templates for certain methods. FASB ASC Topic 326 allows management to
exercise judgment to best reflect its estimate of expected credit
losses given the institution's own unique set of facts and
circumstances. Specific assumptions and determinations appropriate for
one institution may not be appropriate for all other institutions. The
final Policy Statement recognizes that different approaches and
assumptions may be used by management in estimating expected credit
losses. Prescribing only one method for use in estimating expected
credit losses or narrowly defining terms or concepts introduced in ASC
Topic 326 in the final Policy Statement could narrow the flexibility
and scalability provided in FASB ASC Topic 326.
While outside of the scope of the final Policy Statement,
institutions interested in more detailed implementation examples may
continue to refer to the examples included in FASB ASC Topic 326 as
well as FASB Staff Q&A--Topic 326, No. 1, ``Whether the Weighted-
Average Remaining Maturity Method is an Acceptable Method to Estimate
Credit Losses'' \11\ and FASB Staff Q&A--Topic 326, No. 2, ``Developing
an Estimate of Expected Credit Losses on Financial Assets.'' \12\
Institutions may also refer to training events such as the interagency
webinars the agencies conducted during 2018 and 2019. These webinars
reviewed acceptable loss estimation methods including the open pool
loss rate method, vintage method for closed pools, weighted average
remaining maturity (WARM) method, and the probability of default (PD)/
loss given default (LGD) method. The agencies encourage institution
management to discuss FASB ASC Topic 326 and any related questions or
concerns with its board of directors, audit committee, industry peers,
external auditors, and primary federal regulator.\13\
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\11\ See https://www.fasb.org/jsp/FASB/Document_C/DocumentPage&cid=1176171932989.
\12\ See https://www.fasb.org/jsp/FASB/Document_C/DocumentPage&cid=1176172970152.
\13\ Some commenters noted that different messages may be
provided by various parties interested in FASB ASC Topic 326. The
agencies meet regularly with many of these parties, including
external auditors, the FASB, the SEC, the Public Company Accounting
Oversight Board (PCAOB), and industry trade associations, to discuss
FASB ASC Topic 326 to promote consistency in messaging regarding
implementation of the accounting standard.
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[[Page 32993]]
Commenters expressed concern about the level of documentation
needed to support the assumptions and judgments included in an
institution's estimate of expected credit losses. It is consistent with
safe and sound banking practices to maintain documentation that is
appropriate for an institution's size as well as the nature, scope, and
risk of its activities and include clear explanations of the supporting
analysis and rationale used in estimating expected credit losses under
FASB ASC Topic 326. A third party that is independent of the ACL
processes, whether internal or external, should also be able to
understand the methodology used to determine estimated credit losses
through review of the institution's ACL documentation.
The final Policy Statement is one of many steps the agencies have
undertaken in assisting institutions with implementing FASB ASC Topic
326. The agencies will continue to monitor implementation activities
through routine supervisory activities and will determine if any
additional materials or outreach may be needed. The agencies recognize
that FASB ASC Topic 326 may present implementation challenges,
particularly for small community institutions and credit unions. The
agencies may individually issue additional information to provide
clarification beyond what is presented in the final Policy Statement as
deemed necessary.
III. Specific Comments on the Proposed Policy Statement
A. Technical Revisions to the Final Policy Statement
Qualitative Factor Adjustments for Debt Securities
The proposed Policy Statement included a list of qualitative factor
adjustments that may be considered when estimating expected credit
losses for debt securities. Two commenters asked the agencies to
clarify whether qualitative factor adjustments should also be
considered for available-for-sale debt securities.
Expected credit losses for available-for-sale debt securities are
measured using a discounted cash flow method. When estimating expected
cash flows, institutions should consider past events, current
conditions, and reasonable and supportable forecasts. While the
qualitative factors included in the proposed Policy Statement may
affect the institution's cash flow expectations used in the discounted
cash flow calculation, the agencies have no expectation for
institutions to develop and apply a separate qualitative analysis
outside of the discounted cash flow model.
Consistent with FASB ASC Topic 326, qualitative factor adjustments
should be considered and applied, as needed, to held-to-maturity debt
securities. The final Policy Statement has been revised to indicate
that the list of qualitative factor adjustments that may be considered
for debt securities are specific to held-to-maturity debt securities.
Purchased Credit-Deteriorated (PCD) Assets
The proposed Policy Statement states that the non-credit discount
associated with PCD assets and recorded at the time of acquisition
should be accreted into interest income over the remaining life of the
PCD assets on a level-yield basis. One commenter noted that the
proposed Policy Statement does not specify whether the accretion of the
non-credit discount should continue if the PCD asset is placed on
nonaccrual status.
The determination of nonaccrual status for regulatory reporting
purposes is outside of the scope of the final Policy Statement and
institutions should continue to refer to existing regulatory reporting
instructions \14\ for information on reporting nonaccrual PCD assets.
The Federal Financial Institutions Examination Council (FFIEC) will
consider whether clarifications or amendments to the regulatory
reporting instructions are necessary. There were no changes made to the
final Policy Statement for this topic.
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\14\ Institutions required to file the Consolidated Reports of
Condition and Income (Call Report) should refer to instruction pages
RC-N-2 and RC-N-3. Institutions required to file the Consolidated
Financial Statements of Holding Companies (FR Y-9C) should refer to
instruction page HC-N-2. Credit unions required to file the NCUA
Call Report Form 5300 should refer to the instructions for Schedule
A--Specialized Lending.
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Accrued Interest Receivable
The proposed Policy Statement describes the independent accounting
policy elections related to estimating expected credit losses for
accrued interest receivable. It further states that these accounting
policy elections are made upon adoption of FASB ASC Topic 326 and may
differ by financial asset portfolio.
One commenter noted that FASB ASC Topic 326 allows accounting
policy elections for accrued interest receivable to be made by class of
financing receivable or major security-type level, and the proposed
Policy Statement could limit the use of these accounting policy
elections by requiring elections by portfolio.
The agencies did not intend to limit or restrict the use of
accounting policy elections related to accrued interest receivable. The
final Policy Statement has been revised to align the terminology with
FASB ASC Topic 326. Accounting policy elections related to accrued
interest receivable may be made by class of financing receivable or
major security-type.
Estimated Credit Losses for Off-Balance-Sheet Credit Exposures
The proposed Policy Statement explained that expected credit losses
for off-balance-sheet financial assets are estimated using the same
methods applied to similar on-balance-sheet financial assets. The
estimate of expected credit losses is recorded as a liability, separate
from the ACLs, because cash has not yet been disbursed to fund the
contractual obligation to extend credit. The proposed Policy Statement
further explained that the amount needed to adjust the liability for
expected credit losses for off-balance-sheet credit exposures is
reported as an other noninterest expense, consistent with current
regulatory reporting instructions for the Consolidated Reports of
Condition and Income.
Four commenters noted that FASB ASC Topic 326 requires the amount
needed to adjust the liability for expected credit losses for off-
balance-sheet credit exposures to be reported as part of credit loss
expense. Commenters interpreted that this amount should be included in
the provision for credit losses (PCL) rather than other noninterest
expense for financial reporting purposes.
In response to the commenters' recommendation, the FFIEC will
reconsider whether to modify the instructions for the Consolidated
Reports of Condition and Income. The NCUA Call Report Form 5300
currently requires that the expense needed to adjust the liability for
expected credit losses for off-balance-sheet credit exposures should be
reported as a separate provision expense in the income statement.
Additionally, the final Policy Statement has been revised to eliminate
any reference to the income statement category in which amounts needed
to adjust the liability for expected credit losses for off-balance-
sheet credit exposures should be reported in the agencies' regulatory
reports.
B. Estimating Credit Losses With Limited Loss History or Limited Losses
Some commenters requested that the final Policy Statement provide
further guidance on how to estimate expected
[[Page 32994]]
credit losses when there is limited loss history or limited losses.
When an institution has a long history of data with limited credit
losses, management is not expected to default to external or peer data
to determine expected credit losses. Existing data should be evaluated
to determine if adjustments are needed to reflect changes in items such
as the nature of the assets or underwriting terms. When an institution
has loss data covering only recent periods, historical loss information
should be supplemented with external or peer data, industry data, or
qualitative factor adjustments to ensure that expected credit losses
are appropriately captured.
Management should evaluate the facts and circumstances unique to
the institution's financial asset portfolios to determine the
appropriate course of action with respect to data needs. The final
Policy Statement provides sufficient flexibility with respect to
management's evaluation of data needs and was not modified in response
to these concerns.
C. Comparing Actual Credit Losses to Estimated Credit Losses
Three commenters were concerned about the agencies' suggestion in
the proposed Policy Statement to evaluate the ACLs by comparing actual
credit losses to estimated credit losses. As noted by one of these
commenters, actual charge-off experience will not agree to the
quarterly estimate of expected credit losses under FASB ASC Topic 326.
Additionally, one commenter stated that this analysis could not be
relied upon without looking at other metrics.
The agencies are not requiring institutions to compare actual
credit losses to estimated credit losses because there are limitations
in making such a comparison. Although not required, the agencies
consider this comparison useful in analyzing and evaluating the ACLs.
The comparison can assist in evaluating the appropriateness of the ACLs
each quarter and by informing management about the reasonableness of
judgments applicable to future periods. This comparison is only one
point of information available. Other methods, such as ratio
analysis,\15\ may also provide useful information in analyzing the
ACLs. Management may also develop other methods, metrics, or tools not
described in the final Policy Statement to assist in the evaluation and
analysis of the institution's ACLs.
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\15\ As noted in the final Policy Statement, management may also
use peer comparisons to gain insight into its own ACL estimates.
Management should apply caution when performing peer comparisons as
there may be significant differences among peer institutions in the
mix of financial asset portfolios, reasonable and supportable
forecast period assumptions, reversion techniques, the data used for
historical loss information and other factors.
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The agencies are retaining the suggestion to compare actual credit
losses to estimated credit losses in the final Policy Statement.
D. Responsibilities of the Board of Directors
Several commenters stated that the responsibilities of the board of
directors included in the proposed Policy Statement should be
simplified. One of these commenters stated that the responsibilities
should be specifically defined.
The agencies intend for the board of directors' responsibilities to
be appropriate for the institution's size, complexity, and risk
profile. Given the judgmental nature of the ACL methods under FASB ASC
Topic 326, it is important to allow each institution's board of
directors to identify new activities that the board may use to oversee
management's activities. The proposed Policy Statement may also include
oversight activities that are not applicable to certain institutions.
To provide flexibility for each institution and its individual
circumstances, which may change over time, the agencies have not made
any changes to the responsibilities of the board of directors in the
final Policy Statement.
E. Reliance on External Auditor To Perform Management Validation of
ACLs
Commenters asked that the final Policy Statement clearly allow
institutions to rely on external audit firms to perform management's
validation of ACLs to minimize additional expense. External auditors
are subject to applicable auditor independence standards.\16\ The
external auditor's performance of management's responsibilities may
impair the external auditor's independence under those standards if the
external auditor also performs an independent audit of the
institution's financial statements. The final Policy Statement explains
that a party independent of the ACL processes should validate the ACLs.
An independent party may be from an internal audit function, a risk
management unit of the institution, or a contracted third party.
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\16\ For example, external auditors are subject to the annual
audit and reporting requirements in 12 CFR part 363 that apply to
certain FDIC-insured institutions. 12 CFR 363.3(f) states that ``the
independent public accountant must comply with the independence
standards and interpretations of the AICPA, the SEC, and the PCAOB.
To the extent that any of the rules within any of these standards
(AICPA, SEC, and PCAOB) is more or less restrictive than the
corresponding rule in the other independence standards, the
independent accountant must comply with the more restrictive rule.''
12 CFR 715.5 provides requirements for annual audits for federally
insured credit unions and also describes auditor independence
requirements for state licensed auditors.
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The agencies added language to the final Policy Statement to
clarify that external auditor independence may be impaired if the
external auditor performs validation activities for management when the
external auditor also conducts the institution's independent financial
statement audit.
F. Comments Specific to Credit Unions
Several credit unions commented on the proposed Policy Statement
and emphasized that FASB ASC Topic 326 should not apply to credit
unions. Many of these commenters requested that credit unions be
exempted from FASB ASC Topic 326. These exemptions are outside of the
scope of the final Policy Statement and will be addressed in other
communications by the NCUA, if necessary.
At least three commenters requested that the NCUA consider and
evaluate the impact FASB ASC Topic 326 will have on credit union
capital levels. Although the final Policy Statement does not address
capital requirements, the NCUA is considering a rulemaking that will
address the potential impact to regulatory net worth.\17\
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\17\ In late 2019, NCUA Board Chairman Rodney Hood confirmed
that the NCUA has the authority to phase in a ``day one'' adjustment
to net worth that results from the implementation of FASB ASC Topic
326.
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IV. Paperwork Reduction Act
In accordance with the requirements of the Paperwork Reduction Act
of 1995 (PRA),\18\ the agencies may not conduct or sponsor, and the
respondent is not required to respond to, an information collection
unless it displays a currently valid Office of Management and Budget
(OMB) control number.
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\18\ 44 U.S.C. 3501-3521.
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The final Policy Statement does not create any new or revise any
existing collections of information under the PRA. Therefore, no
information collection request will be submitted to the OMB for review.
V. Final Interagency Policy Statement on Allowances for Credit Losses
The text of the final interagency Policy Statement is as follows:
[[Page 32995]]
Interagency Policy Statement on Allowances for Credit Losses
Purpose
The Office of the Comptroller of the Currency (OCC), the Board of
Governors of the Federal Reserve System (FRB), the Federal Deposit
Insurance Corporation (FDIC), and the National Credit Union
Administration (NCUA) (collectively, the agencies) are issuing this
Interagency Policy Statement on Allowances for Credit Losses
(hereafter, the policy statement) to promote consistency in the
interpretation and application of Financial Accounting Standards Board
(FASB) Accounting Standards Update 2016-13, Financial Instruments--
Credit Losses (Topic 326): Measurement of Credit Losses on Financial
Instruments, as well as the amendments issued since June 2016.\1\ These
updates are codified in Accounting Standards Codification (ASC) Topic
326, Financial Instruments--Credit Losses (FASB ASC Topic 326). FASB
ASC Topic 326 applies to all banks, savings associations, credit
unions, and financial institution holding companies (collectively,
institutions), regardless of size, that file regulatory reports for
which the reporting requirements conform to U.S. generally accepted
accounting principles (GAAP).\2\ This policy statement describes the
measurement of expected credit losses in accordance with FASB ASC Topic
326; the design, documentation, and validation of expected credit loss
estimation processes, including the internal controls over these
processes; the maintenance of appropriate allowances for credit losses
(ACLs); the responsibilities of boards of directors and management; and
examiner reviews of ACLs.
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\1\ The FASB issued Accounting Standards Update (ASU) 2016-13 on
June 16, 2016. The following updates were published after the
issuance of ASU 2016-13: ASU 2018-19--Codification Improvements to
Topic 326, Financial Instruments--Credit Losses; ASU 2019-04--
Codification Improvements to Topic 326, Financial Instruments--
Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825,
Financial Instruments; ASU 2019-05--Financial Instruments--Credit
Losses (Topic 326): Targeted Transition Relief; ASU 2019-10--
Financial Instruments--Credit Losses (Topic 326), Derivatives and
Hedging (Topic 815), and Leases (Topic 842): Effective Dates; and
ASU 2019-11--Codification Improvements to Topic 326, Financial
Instruments--Credit Losses. Additionally, institutions may refer to
FASB Staff Q&A-Topic 326, No. 1, Whether the Weighted-Average
Remaining Maturity Method is an Acceptable Method to Estimate
Expected Credit Losses, and FASB Staff Q&A-Topic 326, No. 2,
Developing an Estimate of Expected Credit Losses on Financial
Assets.
\2\ U.S. branches and agencies of foreign banking organizations
may choose to, but are not required to, maintain ACLs on a branch or
agency level. These institutions should refer to the instructions
for the FFIEC 002, Report of Assets and Liabilities of U.S. Branches
and Agencies of Foreign Banks; Supervision and Regulation (SR)
Letter 95-4, Allowance for Loan and Lease Losses for U.S. Branches
and Agencies of Foreign Banking Organizations; and SR Letter 95-42,
Allowance for Loan and Lease Losses for U.S. Branches and Agencies
of Foreign Banking Organizations.
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This policy statement is effective at the time of each
institution's adoption of FASB ASC Topic 326.\3\ The following policy
statements are no longer effective for an institution upon its adoption
of FASB ASC Topic 326: The December 2006 Interagency Policy Statement
on the Allowance for Loan and Lease Losses; the July 2001 Policy
Statement on Allowance for Loan and Lease Losses Methodologies and
Documentation for Banks and Savings Institutions; and the NCUA's May
2002 Interpretive Ruling and Policy Statement 02-3, Allowance for Loan
and Lease Losses Methodologies and Documentation for Federally Insured
Credit Unions (collectively, ALLL Policy Statements). After FASB ASC
Topic 326 is effective for all institutions, the agencies will rescind
the ALLL Policy Statements.
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\3\ As noted in Accounting Standards Update 2019-10, FASB ASC
Topic 326 is effective for fiscal years beginning after December 15,
2019, including interim periods within those fiscal years, for
public business entities that meet the definition of a Securities
Exchange Commission (SEC) filer, excluding entities eligible to be
small reporting companies as defined by the SEC. FASB ASC Topic 326
is effective for all other entities for fiscal years beginning after
December 15, 2022, including interim periods within those fiscal
years. For all entities, early application of FASB ASC Topic 326 is
permitted as set forth in ASU 2016-13.
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The principles described in this policy statement are consistent
with GAAP, applicable regulatory reporting requirements,\4\ safe and
sound banking practices, and the agencies' codified guidelines
establishing standards for safety and soundness.\5\ The operational and
managerial standards included in those guidelines, which address such
matters as internal controls and information systems, an internal audit
system, loan documentation, credit underwriting, asset quality, and
earnings, should be appropriate for an institution's size and the
nature, scope, and risk of its activities.
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\4\ For FDIC-insured depository institutions, section 37(a) of
the Federal Deposit Insurance Act (12 U.SC. 1831n(a)) states that,
in general, the accounting principles applicable to the Consolidated
Reports of Condition and Income (Call Report) ``shall be uniform and
consistent with generally accepted accounting principles.'' Section
202(a)(6)(C) of the Federal Credit Union Act (12 U.S.C.
1782(a)(6)(C)) establishes the same standard for federally insured
credit unions with assets of $10 million or greater, providing that,
in general, the ``[a]ccounting principles applicable to reports or
statements required to be filed with the [NCUA] Board by each
insured credit union shall be uniform and consistent with generally
accepted accounting principles.'' Furthermore, regardless of asset
size, all federally insured credit unions must comply with GAAP for
certain financial reporting requirements relating to charges for
loan losses. See 12 CFR 702.402(d).
\5\ FDIC-insured depository institutions should refer to the
Interagency Guidelines Establishing Standards for Safety and
Soundness adopted by their primary Federal regulator pursuant to
section 39 of the Federal Deposit Insurance Act (12 U.S.C. 1831p-1)
as follows: For national banks and Federal savings associations,
Appendix A to 12 CFR part 30; for state member banks, Appendix D to
12 CFR part 208; and for state nonmember banks, state savings
associations, and insured state-licensed branches of foreign banks,
Appendix A to 12 CFR part 364. Federally insured credit unions
should refer to section 206(b)(1) of the Federal Credit Union Act
(12 U.S.C. 1786) and 12 CFR 741.3.
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Scope
This policy statement describes the current expected credit losses
(CECL) methodology for determining the ACLs applicable to loans held-
for-investment, net investments in leases, and held-to-maturity debt
securities accounted for at amortized cost.\6\ It also describes the
estimation of the ACL for an available-for-sale debt security in
accordance with FASB ASC Subtopic 326-30. This policy statement does
not address or supersede existing agency requirements or guidance
regarding appropriate due diligence in connection with the purchase or
sale of assets or determining whether assets are permissible to be
purchased or held by institutions.\7\
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\6\ FASB ASC Topic 326 defines the amortized cost basis as the
amount at which a financing receivable or investment is originated
or acquired, adjusted for applicable accrued interest, accretion, or
amortization of premium, discount, and net deferred fees or costs,
collection of cash, write-offs, foreign exchange, and fair value
hedge accounting adjustments.
\7\ See the final guidance attached to OCC Bulletin 2012-18,
Guidance on Due Diligence Requirements in Determining Whether
Securities Are Eligible for Investment (for national banks and
Federal savings associations), 12 CFR part 1, Investment Securities
(for national banks), and 12 CFR part 160, Lending and Investment
(for Federal savings associations). Federal credit unions should
refer to 12 CFR part 703, Investment and Deposit Activities.
Federally insured, state-chartered credit unions should refer to
applicable state laws and regulations, as well as 12 CFR 741.219
(``investment requirements'').
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The CECL methodology described in FASB ASC Topic 326 applies to
financial assets measured at amortized cost, net investments in leases,
and off-balance-sheet credit exposures (collectively, financial assets)
including:
Financing receivables such as loans held-for-investment;
Overdrawn deposit accounts (i.e., overdrafts) that are
reclassified as held-for-investment loans;
Held-to-maturity debt securities;
Receivables that result from revenue transactions within
the scope of Topic 606 on revenue from contracts with customers and
Topic 610 on other income, which applies, for example, to the sale of
foreclosed real estate;
[[Page 32996]]
Reinsurance recoverables that result from insurance
transactions within the scope of Topic 944 on insurance;
Receivables related to repurchase agreements and
securities lending agreements within the scope of Topic 860 on
transfers and servicing;
Net investments in leases recognized by a lessor in
accordance with Topic 842 on leases; and
Off-balance-sheet credit exposures including off-balance-
sheet loan commitments, standby letters of credit, financial guarantees
not accounted for as insurance, and other similar instruments except
for those within the scope of Topic 815 on derivatives and hedging.
The CECL methodology does not apply to the following financial
assets:
Financial assets measured at fair value through net
income, including those assets for which the fair value option has been
elected;
Available-for-sale debt securities; \8\
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\8\ Refer to FASB ASC Subtopic 326-30, Financial Instruments--
Credit Losses--Available-for-Sale Debt Securities (FASB ASC Subtopic
326-30).
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Loans held-for-sale;
Policy loan receivables of an insurance entity;
Loans and receivables between entities under common
control; and
Receivables arising from operating leases.
Measurement of ACLs for Loans, Leases, Held-To-Maturity Debt
Securities, and Off-Balance-Sheet Credit Exposures
Overview of ACLs
An ACL is a valuation account that is deducted from, or added to,
the amortized cost basis of financial assets to present the net amount
expected to be collected over the contractual term \9\ of the assets.
In estimating the net amount expected to be collected, management
should consider the effects of past events, current conditions, and
reasonable and supportable forecasts on the collectibility of the
institution's financial assets.\10\ FASB ASC Topic 326 requires
management to use relevant forward-looking information and expectations
drawn from reasonable and supportable forecasts when estimating
expected credit losses.
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\9\ Consistent with FASB ASC Topic 326, an institution's
determination of the contractual term should reflect the financial
asset's contractual life adjusted for prepayments, renewal and
extension options that are not unconditionally cancellable by the
institution, and reasonably expected troubled debt restructurings.
For more information, see the ``Contractual Term of a Financial
Asset'' section in this policy statement.
\10\ Recoveries are a component of management's estimation of
the net amount expected to be collected for a financial asset.
Expected recoveries of amounts previously written off or expected to
be written off that are included in ACLs may not exceed the
aggregate amounts previously written off or expected to be written
off. In some circumstances, the ACL for a specific portfolio or loan
may be negative because the amount expected to be collected,
including expected recoveries, exceeds the financial asset's
amortized cost basis.
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ACLs are evaluated as of the end of each reporting period. The
methods used to determine ACLs generally should be applied consistently
over time and reflect management's current expectations of credit
losses. Changes to ACLs resulting from these periodic evaluations are
recorded through increases or decreases to the related provisions for
credit losses (PCLs). When available information confirms that specific
loans, securities, other assets, or portions thereof, are
uncollectible, these amounts should be promptly written off \11\
against the related ACLs.
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\11\ Consistent with FASB ASC Topic 326, this policy statement
uses the verbs ``write off'' and ``written off'' and the noun
``write-off.'' These terms are used interchangeably with ``charge
off,'' ``charged off,'' and ``charge-off,'' respectively, in the
agencies' regulations, guidance, and regulatory reporting
instructions.
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Estimating appropriate ACLs involves a high degree of management
judgment and is inherently imprecise. An institution's process for
determining appropriate ACLs may result in a range of estimates for
expected credit losses. An institution should support and record its
best estimate within the range of expected credit losses.
Collective Evaluation of Expected Losses
FASB ASC Topic 326 requires expected losses to be evaluated on a
collective, or pool, basis when financial assets share similar risk
characteristics. Financial assets may be segmented based on one
characteristic, or a combination of characteristics.
Examples of risk characteristics relevant to this evaluation
include, but are not limited to:
Internal or external credit scores or credit ratings;
Risk ratings or classifications;
Financial asset type;
Collateral type;
Size;
Effective interest rate;
Term;
Geographical location;
Industry of the borrower; and
Vintage.
Other risk characteristics that may be relevant for segmenting
held-to-maturity debt securities include issuer, maturity, coupon rate,
yield, payment frequency, source of repayment, bond payment structure,
and embedded options.
FASB ASC Topic 326 does not prescribe a process for segmenting
financial assets for collective evaluation. Therefore, management
should exercise judgment when establishing appropriate segments or
pools. Management should evaluate financial asset segmentation on an
ongoing basis to determine whether the financial assets in the pool
continue to share similar risk characteristics. If a financial asset
ceases to share risk characteristics with other assets in its segment,
it should be moved to a different segment with assets sharing similar
risk characteristics if such a segment exists.
If a financial asset does not share similar risk characteristics
with other assets, expected credit losses for that asset should be
evaluated individually. Individually evaluated assets should not be
included in a collective assessment of expected credit losses.
Estimation Methods for Expected Credit Losses
FASB ASC Topic 326 does not require the use of a specific loss
estimation method for purposes of determining ACLs. Various methods may
be used to estimate the expected collectibility of financial assets,
with those methods generally applied consistently over time. The same
loss estimation method does not need to be applied to all financial
assets. Management is not precluded from selecting a different method
when it determines the method will result in a better estimate of ACLs.
Management may use a loss-rate method,\12\ probability of default/
loss given default (PD/LGD) method, roll-rate method, discounted cash
flow method, a method that uses aging schedules, or another reasonable
method to estimate expected credit losses. The selected method(s)
should be appropriate for the financial assets being evaluated,
consistent with the institution's size and complexity.
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\12\ Various loss-rate methods may be used to estimate expected
credit losses under the CECL methodology. These include the
weighted-average remaining maturity (WARM) method, vintage analysis,
and the snapshot or open pool method.
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Contractual Term of a Financial Asset
FASB ASC Topic 326 requires an institution to measure estimated
expected credit losses over the contractual term of its financial
assets, considering expected prepayments. Renewals, extensions, and
modifications are excluded from the contractual term of a financial
asset for purposes of estimating the ACL unless there is a reasonable
expectation of executing a troubled debt restructuring (TDR) or the
renewal and extension options are part of the original or modified
contract and are not
[[Page 32997]]
unconditionally cancellable by the institution. If such renewal or
extension options are present, management must evaluate the likelihood
of a borrower exercising those options when determining the contractual
term.
Historical Loss Information
Historical loss information generally provides a basis for an
institution's assessment of expected credit losses. Historical loss
information may be based on internal information, external information,
or a combination of both. Management should consider whether the
historical loss information may need to be adjusted for differences in
current asset specific characteristics such as differences in
underwriting standards, portfolio mix, or when historical asset terms
do not reflect the contractual terms of the financial assets being
evaluated as of the reporting date.
Management should then consider whether further adjustments to
historical loss information are needed to reflect the extent to which
current conditions and reasonable and supportable forecasts differ from
the conditions that existed during the historical loss period.
Adjustments to historical loss information may be quantitative or
qualitative in nature and should reflect changes to relevant data (such
as changes in unemployment rates, delinquency, or other factors
associated with the financial assets).
Reasonable and Supportable Forecasts
When estimating expected credit losses, FASB ASC Topic 326 requires
management to consider forward-looking information that is both
reasonable and supportable and relevant to assessing the collectibility
of cash flows. Reasonable and supportable forecasts may extend over the
entire contractual term of a financial asset or a period shorter than
the contractual term. FASB ASC Topic 326 does not prescribe a specific
method for determining reasonable and supportable forecasts nor does it
include bright lines for establishing a minimum or maximum length of
time for reasonable and supportable forecast period(s). Judgment is
necessary in determining an appropriate period(s) for each institution.
Reasonable and supportable forecasts may vary by portfolio segment or
individual forecast input. These forecasts may include data from
internal sources, external sources, or a combination of both.
Management is not required to search for all possible information nor
incur undue cost and effort to collect data for its forecasts. However,
reasonably available and relevant information should not be ignored in
assessing the collectibility of cash flows. Management should evaluate
the appropriateness of the reasonable and supportable forecast
period(s) each reporting period, consistent with other inputs used in
the estimation of expected credit losses.
Institutions may develop reasonable and supportable forecasts by
using one or more economic scenarios. FASB ASC Topic 326 does not
require the use of multiple economic scenarios; however, institutions
are not precluded from considering multiple economic scenarios when
estimating expected credit losses.
Reversion
When the contractual term of a financial asset extends beyond the
reasonable and supportable period, FASB ASC Topic 326 requires
reverting to historical loss information, or an appropriate proxy, for
those periods beyond the reasonable and supportable forecast period
(often referred to as the reversion period). Management may revert to
historical loss information for each individual forecast input or based
on the entire estimate of loss.
FASB ASC Topic 326 does not require the application of a specific
reversion technique or use of a specific reversion period. Reversion to
historical loss information may be immediate, occur on a straight-line
basis, or use any systematic, rational method. Management may apply
different reversion techniques depending on the economic environment or
the financial asset portfolio. Reversion techniques are not accounting
policy elections and should be evaluated for appropriateness each
reporting period, consistent with other inputs used in the estimation
of expected credit losses.
FASB ASC Topic 326 does not specify the historical loss information
that is used in the reversion period. This historical loss information
may be based on long-term average losses or on losses that occurred
during a particular historical period(s). Management may use multiple
historical periods that are not sequential. Management should not
adjust historical loss information for existing economic conditions or
expectations of future economic conditions for periods beyond the
reasonable and supportable period. However, management should consider
whether the historical loss information may need to be adjusted for
differences in current asset specific characteristics such as
differences in underwriting standards, portfolio mix, or when
historical asset terms do not reflect the contractual terms of the
financial assets being evaluated as of the reporting date.
Qualitative Factor Adjustments
The estimation of ACLs should reflect consideration of all
significant factors relevant to the expected collectibility of the
institution's financial assets as of the reporting date. Management may
begin the expected credit loss estimation process by determining its
historical loss information or obtaining reliable and relevant
historical loss proxy data for each segment of financial assets with
similar risk characteristics. Historical credit losses (or even recent
trends in losses) generally do not, by themselves, form a sufficient
basis to determine the appropriate levels for ACLs.
Management should consider the need to qualitatively adjust
expected credit loss estimates for information not already captured in
the loss estimation process. These qualitative factor adjustments may
increase or decrease management's estimate of expected credit losses.
Adjustments should not be made for information that has already been
considered and included in the loss estimation process.
Management should consider the qualitative factors that are
relevant to the institution as of the reporting date, which may
include, but are not limited to:
The nature and volume of the institution's financial
assets;
The existence, growth, and effect of any concentrations of
credit;
The volume and severity of past due financial assets, the
volume of nonaccrual assets, and the volume and severity of adversely
classified or graded assets; \13\
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\13\ For banks and savings associations, adversely classified or
graded loans are loans rated ``substandard'' (or its equivalent) or
worse under the institution's loan classification system. For credit
unions, adversely graded loans are loans included in the more
severely graded categories under the institution's credit grading
system, i.e., those loans that tend to be included in the credit
union's ``watch lists.'' Criteria related to the classification of
an investment security may be found in the interagency policy
statement Uniform Agreement on the Classification and Appraisal of
Securities Held by Depository Institutions issued by the FDIC,
Board, and OCC in October 2013.
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The value of the underlying collateral for loans that are
not collateral-dependent; \14\
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\14\ See the ``Collateral-Dependent Financial Assets'' section
of this policy statement for more information on collateral-
dependent loans.
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The institution's lending policies and procedures,
including changes in underwriting standards and practices for
collections, write-offs, and recoveries;
The quality of the institution's credit review function;
The experience, ability, and depth of the institution's
lending, investment,
[[Page 32998]]
collection, and other relevant management and staff;
The effect of other external factors such as the
regulatory, legal and technological environments; competition; and
events such as natural disasters; and
Actual and expected changes in international, national,
regional, and local economic and business conditions and developments
\15\ in which the institution operates that affect the collectibility
of financial assets.
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\15\ Changes in economic and business conditions and
developments included in qualitative factor adjustments are limited
to those that affect the collectibility of an institution's
financial assets and are relevant to the institution's financial
asset portfolios. For example, an economic factor for current or
forecasted unemployment at the national or state level may indicate
a strong job market based on low national or state unemployment
rates, but a local unemployment rate, which may be significantly
higher, for example, because of the actual or forecasted loss of a
major local employer may be more relevant to the collectibility of
an institution's financial assets.
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Management may consider the following additional qualitative
factors specific to held-to-maturity debt securities as of the
reporting date: \16\
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\16\ This list is not all-inclusive, and all of the factors
listed may not be relevant to all institutions.
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The effect of recent changes in investment strategies and
policies;
The existence and effect of loss allocation methods, the
definition of default, the impact of performance and market value
triggers, and credit and liquidity enhancements associated with debt
securities;
The effect of structural subordination and collateral
deterioration on tranche performance of debt securities;
The quality of underwriting for any collateral backing
debt securities; and
The effect of legal covenants associated with debt
securities.
Changes in the level of an institution's ACLs may not always be
directionally consistent with changes in the level of qualitative
factor adjustments due to the incorporation of reasonable and
supportable forecasts in estimating expected losses. For example, if
improving credit quality trends are evident throughout an institution's
portfolio in recent years, but management's evaluation of reasonable
and supportable forecasts indicates expected deterioration in credit
quality of the institution's financial assets during the forecast
period, the ACL as a percentage of the portfolio may increase.
Collateral-Dependent Financial Assets
FASB ASC Topic 326 describes a collateral-dependent asset 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, based on management's assessment, is experiencing financial
difficulty as of the reporting date. For regulatory reporting purposes,
the ACL for a collateral-dependent loan is measured using the fair
value of collateral, regardless of whether foreclosure is probable.\17\
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\17\ The agencies, at times, prescribe specific regulatory
reporting requirements that fall within a range of acceptable
practice under GAAP. These specific reporting requirements, such as
the requirement for institutions to apply the practical expedient in
ASC 326-20-35-5 for collateral-dependent loans, regardless of
whether foreclosure is probable, have been adopted to achieve safety
and soundness and other public policy objectives and to ensure
comparability among institutions. The regulatory reporting
requirement to apply the practical expedient for collateral-
dependent financial assets is consistent with the agencies' long-
standing practice for collateral-dependent loans, and it continues
to be limited to collateral-dependent loans. It does not apply to
other financial assets such as held-to-maturity debt securities that
are collateral-dependent.
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When estimating the ACL for a collateral-dependent loan, FASB ASC
Topic 326 requires the fair value of collateral to be adjusted to
consider estimated costs to sell if repayment or satisfaction of the
loan depends on the sale of the collateral. ACL adjustments for
estimated costs to sell are not appropriate when the repayment of a
collateral-dependent loan is expected from the operation of the
collateral.
The fair value of collateral securing a collateral-dependent loan
may change over time. If the fair value of the collateral as of the ACL
evaluation date has decreased since the previous ACL evaluation date,
the ACL should be increased to reflect the additional decrease in the
fair value of the collateral. Likewise, if the fair value of the
collateral has increased as of the ACL evaluation date, the increase in
the fair value of the collateral is reflected through a reduction in
the ACL. Any negative ACL that results is capped at the amount
previously written off. Changes in the fair value of collateral
described herein should be supported and documented through recent
appraisals or evaluations.\18\
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\18\ For more information on regulatory expectations related to
the use of appraisals and evaluations, see the Interagency Appraisal
and Evaluation Guidelines published on December 10, 2010. Insured
depository institutions should also refer to the interagency
regulations on appraisals adopted by their primary Federal regulator
as follows: For national banks and Federal savings associations,
Subpart C of 12 CFR part 34; for state member banks, 12 CFR parts
208 and 225; for state nonmember banks, state savings associations,
and insured state-licensed branches of foreign banks, 12 CFR part
323; and for federally insured credit unions, 12 CFR part 722.
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Troubled Debt Restructurings \19\
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\19\ A troubled debt restructuring is defined in ASC Subtopic
310-40, Receivables--Troubled Debt Restructurings by Creditors. The
October 24, 2013, Interagency Supervisory Guidance Addressing
Certain Issues Related to Troubled Debt Restructurings provides more
information on TDRs including, but not limited to, accrual status,
regulatory credit risk grade, classification and write-off
treatment, and capitalized costs. This interagency supervisory
guidance remains applicable, unless affected by FASB ASC Topic 326.
Information on the reporting of a subsequent restructuring of a TDR
may be found in the instructions for the Call Report.
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Expected credit losses on financial assets modified in TDRs or
reasonably expected to be modified in TDRs (collectively, TDRs) are
estimated under the same CECL methodology that is applied to other
financial assets measured at amortized cost. Expected credit losses are
evaluated on a collective basis, or, if a TDR does not share similar
risk characteristics with other financial assets, on an individual
basis.
FASB ASC Topic 326 allows an institution to use any appropriate
loss estimation method to estimate ACLs for TDRs. However, there are
circumstances when specific measurement methods are required. If a TDR,
or a financial asset for which a TDR is reasonably expected, is
collateral-dependent, the ACL is estimated using the fair value of
collateral.
In addition, when management has a reasonable expectation of
executing a TDR or if a TDR has been executed, the expected effect of
the modification (e.g., term extension or interest rate concession) is
included in the estimate of the ACLs. Management should determine,
support, and document how it identifies and estimates the effect of a
reasonably expected TDR and estimates the related ACL. The estimated
effect of reasonably expected TDRs may be included in an institution's
qualitative factor adjustments.
Purchased Credit-Deteriorated Assets
FASB ASC Topic 326 introduces the concept of purchased credit-
deteriorated (PCD) assets. PCD assets are acquired financial assets
that, at acquisition, have experienced more-than-insignificant
deterioration in credit quality since origination. FASB ASC Topic 326
does not provide a prescriptive definition of more-than-insignificant
credit deterioration. The acquiring institution's management should
establish and document a reasonable process to consistently determine
what constitutes a more-than-insignificant deterioration in credit
quality.
[[Page 32999]]
When recording the acquisition of PCD assets, the amount of
expected credit losses as of the acquisition date is added to the
purchase price of the financial assets rather than recording these
losses through PCLs. This establishes the amortized cost basis of the
PCD assets. Any difference between the unpaid principal balance of the
PCD assets and the amortized cost basis of the assets as of the
acquisition date is the non-credit discount or premium. The initial ACL
and non-credit discount or premium determined on a collective basis at
the acquisition date are allocated to the individual PCD assets.
After acquisition, ACLs for PCD assets should be adjusted at each
reporting date with a corresponding debit or credit to the PCLs to
reflect management's current estimate of expected credit losses. The
non-credit discount recorded at acquisition will be accreted into
interest income over the remaining life of the PCD assets on a level-
yield basis.
Financial Assets With Collateral Maintenance Agreements
Institutions may have financial assets that are secured by
collateral (such as debt securities) and are subject to collateral
maintenance agreements requiring the borrower to continuously replenish
the amount of collateral securing the asset. If the fair value of the
collateral declines, the borrower is required to provide additional
collateral as specified by the agreement.
FASB ASC Topic 326 includes a practical expedient for financial
assets with collateral maintenance agreements where the borrower is
required to provide collateral greater than or equal to the amortized
cost basis of the asset and is expected to continuously replenish the
collateral. In those cases, management may elect the collateral
maintenance practical expedient and measure expected credit losses for
these qualifying assets based on the fair value of the collateral.\20\
If the fair value of the collateral is greater than the amortized cost
basis of the financial asset and management expects the borrower to
replenish collateral as needed, management may record an ACL of zero
for the financial asset when the collateral maintenance practical
expedient is applied. Similarly, if the fair value of the collateral is
less than the amortized cost basis of the financial asset and
management expects the borrower to replenish collateral as needed, the
ACL is limited to the difference between the fair value of the
collateral and the amortized cost basis of the asset as of the
reporting date when applying the collateral maintenance practical
expedient.
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\20\ For example, an institution enters into a reverse
repurchase agreement with a collateral maintenance agreement.
Management may not need to record the expected credit losses at each
reporting date as long as the fair value of the security collateral
is greater than the amortized cost basis of the reverse repurchase
agreement. Refer to ASC 326-20-55-46 for more information.
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Accrued Interest Receivable
FASB ASC Topic 326 includes accrued interest receivable in the
amortized cost basis of a financial asset. As a result, accrued
interest receivable is included in the amounts for which ACLs are
estimated. Generally, any accrued interest receivable that is not
collectible is written off against the related ACL.
FASB ASC Topic 326 permits a series of independent accounting
policy elections related to accrued interest receivable that alter the
accounting treatment described in the preceding paragraph. These
elections are made upon adoption of FASB ASC Topic 326 and may differ
by class of financing receivable or major security-type level. The
available accounting policy elections \21\ are:
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\21\ The accounting policy elections related to accrued interest
receivable that are described in this paragraph also apply to
accrued interest receivable for an available-for-sale debt security
that, for purposes of identifying and measuring an impairment,
exclude the applicable accrued interest from both the fair value and
amortized cost basis of the securities.
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Management may elect not to measure ACLs for accrued
interest receivable if uncollectible accrued interest is written off in
a timely manner. Management should define and document its definition
of a timely write-off.
Management may elect to write off accrued interest
receivable by either reversing interest income, recognizing the loss
through PCLs, or through a combination of both methods.
Management may elect to separately present accrued
interest receivable from the associated financial asset in its
regulatory reports and financial statements, if applicable. The accrued
interest receivable is presented net of ACLs (if any).
Financial Assets With Zero Credit Loss Expectations
There may be certain financial assets for which the expectation of
credit loss is zero after evaluating historical loss information,
making necessary adjustments for current conditions and reasonable and
supportable forecasts, and considering any collateral or guarantee
arrangements that are not free-standing contracts. Factors to consider
when evaluating whether expectations of zero credit loss are
appropriate may include, but are not limited to:
A long history of zero credit loss;
A financial asset that is fully secured by cash or cash
equivalents;
High credit ratings from rating agencies with no expected
future downgrade; \22\
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\22\ Management should not rely solely on credit rating agencies
but should also make its own assessment based on third party
research, default statistics, and other data that may indicate a
decline in credit rating.
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Principal and interest payments that are guaranteed by the
U.S. government;
The issuer, guarantor, or sponsor can print its own
currency and the currency is held by other central banks as reserve
currency; and
The interest rate on the security is recognized as a risk-
free rate.
A loan that is fully secured by cash or cash equivalents, such as
certificates of deposit issued by the lending institution, would likely
have zero credit loss expectations. Similarly, the guaranteed portion
of a U.S. Small Business Administration (SBA) loan or security
purchased on the secondary market through the SBA's fiscal and transfer
agent would likely have zero credit loss expectations if these
financial assets are unconditionally guaranteed by the U.S. government.
Examples of held-to-maturity debt securities that may result in
expectations of zero credit loss include U.S. Treasury securities as
well as mortgage-backed securities issued and guaranteed by the
Government National Mortgage Association, the Federal Home Loan
Mortgage Corporation, and the Federal National Mortgage Association.
Assumptions related to zero credit loss expectations should be included
in the institution's ACL documentation.
Estimated Credit Losses for Off-Balance-Sheet Credit Exposures
FASB ASC Topic 326 requires that an institution estimate expected
credit losses for off-balance-sheet credit exposures within the scope
of FASB ASC Topic 326 over the contractual period during which the
institution is exposed to credit risk. The estimate of expected credit
losses should take into consideration the likelihood that funding will
occur as well as the amount expected to be funded over the estimated
remaining contractual term of the off-balance-sheet credit exposures.
Management should not record an estimate of expected credit losses for
off-balance-sheet exposures that are
[[Page 33000]]
unconditionally cancellable by the issuer.
Management must evaluate expected credit losses for off-balance-
sheet credit exposures as of each reporting date. While the process for
estimating expected credit losses for these exposures is similar to the
one used for on-balance-sheet financial assets, these estimated credit
losses are not recorded as part of the ACLs because cash has not yet
been disbursed to fund the contractual obligation to extend credit.
Instead, these loss estimates are recorded as a liability, separate and
distinct from the ACLs.\23\ The amount needed to adjust the liability
for expected credit losses for off-balance-sheet credit exposures as of
each reporting date is reported in net income.
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\23\ The ACL associated with off-balance-sheet credit exposures
is included in the ``Allowance for credit losses on off-balance-
sheet credit exposures'' in Schedule RC-G--Other Liabilities in the
Call Report and in the Liabilities schedule in NCUA Call Report Form
5300.
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Measurement of the ACL for Available-for-Sale Debt Securities
FASB ASC Subtopic 326-30, Financial Instruments--Credit Losses--
Available-for-Sale Debt Securities (FASB ASC Subtopic 326-30) describes
the accounting for expected credit losses associated with available-
for-sale debt securities. Credit losses for available-for-sale debt
securities are evaluated as of each reporting date when the fair value
is less than amortized cost. FASB ASC Subtopic 326-30 requires credit
losses to be calculated individually, rather than collectively, using a
discounted cash flow method, through which management compares the
present value of expected cash flows with the amortized cost basis of
the security. An ACL is established, with a charge to the PCL, to
reflect the credit loss component of the decline in fair value below
amortized cost. If the fair value of the security increases over time,
any ACL that has not been written off may be reversed through a credit
to the PCL. The ACL for an available-for-sale debt security is limited
by the amount that the fair value is less than the amortized cost,
which is referred to as the fair value floor.
If management intends to sell an available-for-sale debt security
or will more likely than not be required to sell the security before
recovery of the amortized cost basis, the security's ACL should be
written off and the amortized cost basis of the security should be
written down to its fair value at the reporting date with any
incremental impairment reported in income.
A change during the reporting period in the non-credit component of
any decline in fair value below amortized cost on an available-for-sale
debt security is reported in other comprehensive income, net of
applicable income taxes.\24\
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\24\ Non-credit impairment on an available-for-sale debt
security that is not required to be recorded through the ACL should
be reported in other comprehensive income as described in ASC 326-
30-35-2.
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When evaluating impairment for available-for-sale debt securities,
management may evaluate the amortized cost basis including accrued
interest receivable, or may evaluate the accrued interest receivable
separately from the remaining amortized cost basis. If evaluated
separately, accrued interest receivable is excluded from both the fair
value of the available-for-sale debt security and its amortized cost
basis.\25\
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\25\ The accounting policy elections described in the ``Accrued
Interest Receivable'' section of this policy statement apply to
accrued interest receivable recorded for an available-for-sale debt
security if an institution excludes applicable accrued interest
receivable from both the fair value and amortized cost basis of the
security for purposes of identifying and measuring impairment.
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Documentation Standards
For financial and regulatory reporting purposes, ACLs and PCLs must
be determined in accordance with GAAP. ACLs and PCLs should be well
documented, with clear explanations of the supporting analyses and
rationale. Sound policies, procedures, and control systems should be
appropriately tailored to an institution's size and complexity,
organizational structure, business environment and strategy, risk
appetite, financial asset characteristics, loan administration
procedures, investment strategy, and management information
systems.\26\ Maintaining, analyzing, supporting, and documenting
appropriate ACLs and PCLs in accordance with GAAP is consistent with
safe and sound banking practices.
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\26\ Management often documents policies, procedures, and
controls related to ACLs in accounting or credit risk management
policies, or a combination thereof.
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The policies and procedures governing an institution's ACL
processes and the controls over these processes should be designed,
implemented, and maintained to reasonably estimate expected credit
losses for financial assets and off-balance-sheet credit exposures as
of the reporting date. The policies and procedures should describe
management's processes for evaluating the credit quality and
collectibility of financial asset portfolios, including reasonable and
supportable forecasts about changes in the credit quality of these
portfolios, through a disciplined and consistently applied process that
results in an appropriate estimate of the ACLs. Management should
review and, as needed, revise the institution's ACL policies and
procedures at least annually, or more frequently if necessary.
An institution's policies and procedures for the systems,
processes, and controls necessary to maintain appropriate ACLs should
address, but not be limited to:
Processes that support the determination and maintenance
of appropriate levels for ACLs that are based on a comprehensive, well-
documented, and consistently applied analysis of an institution's
financial asset portfolios and off-balance-sheet credit exposures. The
analyses and loss estimation processes used should consider all
significant factors that affect the credit risk and collectibility of
the financial asset portfolios;
The roles, responsibilities, and segregation of duties of
the institution's senior management and other personnel who provide
input into ACL processes, determine ACLs, or review ACLs. These
departments and individuals may include accounting, financial
reporting, treasury, investment management, lending, special asset or
problem loan workout teams, retail collections and foreclosure groups,
credit review, model risk management, internal audit, and others, as
applicable. Individuals with responsibilities related to the estimation
of ACLs should be competent and well-trained, with the ability to
escalate material issues;
Processes for determining the appropriate historical
period(s) to use as the basis for estimating expected credit losses and
approaches for adjusting historical credit loss information to reflect
differences in asset specific characteristics, as well as current
conditions and reasonable and supportable forecasts that are different
from conditions existing in the historical period(s);
Processes for determining and revising the appropriate
techniques and periods to revert to historical credit loss information
when the contractual term of a financial asset or off-balance-sheet
credit exposure extends beyond the reasonable and supportable forecast
period(s);
Processes for segmenting financial assets for estimating
expected credit losses and periodically evaluating the segments to
determine whether the assets continue to share similar risk
characteristics;
Data capture and reporting systems that supply the quality
and breadth of
[[Page 33001]]
relevant and reliable information necessary, whether obtained
internally or externally, to support and document the estimates of
appropriate ACLs for regulatory reporting requirements and, if
applicable, financial statement and disclosure requirements;
The description of the institution's systematic and
logical loss estimation process(es) for determining and consolidating
expected credit losses to ensure that the ACLs are recorded in
accordance with GAAP and regulatory reporting requirements. This may
include, but is not limited to:
[cir] Management's judgments, accounting policy elections, and
application of practical expedients in determining the amount of
expected credit losses;
[cir] The process for determining when a loan is collateral-
dependent;
[cir] The process for determining the fair value of collateral, if
any, used as an input when estimating the ACL, including the basis for
making any adjustments to the market value conclusion and how costs to
sell, if applicable, are calculated;
[cir] The process for determining when a financial asset has zero
credit loss expectations;
[cir] The process for determining expected credit losses when a
financial asset has a collateral maintenance provision; and
[cir] A description of and support for qualitative factors that
affect collectibility of financial assets;
Procedures for validating and independently reviewing the
loss estimation process as well as any changes to the process from
prior periods;
Policies and procedures for the prompt write-off of
financial assets, or portions of financial assets, when available
information confirms the assets to be uncollectible, consistent with
regulatory reporting requirements; and
The systems of internal controls used to confirm that the
ACL processes are maintained and periodically adjusted in accordance
with GAAP and interagency guidelines establishing standards for safety
and soundness.
Internal control systems for the ACL estimation processes should:
Provide reasonable assurance regarding the relevance,
reliability, and integrity of data and other information used in
estimating expected credit losses;
Provide reasonable assurance of compliance with laws,
regulations, and the institution's policies and procedures;
Provide reasonable assurance that the institution's
financial statements are prepared in accordance with GAAP, and the
institution's regulatory reports are prepared in accordance with the
applicable instructions;
Include a well-defined and effective loan review and
grading process that is consistently applied and identifies, measures,
monitors, and reports asset quality problems in an accurate, sound and
timely manner. The loan review process should respond to changes in
internal and external factors affecting the level of credit risk in the
portfolio; and
Include a well-defined and effective process for
monitoring credit quality in the debt securities portfolio.
Analyzing and Validating the Overall Measurement of ACLs
To ensure that ACLs are presented fairly, in accordance with GAAP
and regulatory reporting requirements, and are transparent for
regulatory examinations, management should document its measurements of
the amounts of ACLs reported in regulatory reports and financial
statements, if applicable, for each type of financial asset (e.g.,
loans, held-to-maturity debt securities, and available-for-sale debt
securities) and for off-balance-sheet credit exposures. This
documentation should include ACL calculations, qualitative adjustments,
and any adjustments to the ACLs that are required as part of the
internal review and challenge process. The board of directors, or a
committee thereof, should review management's assessments of and
justifications for the reported amounts of ACLs.
Various techniques are available to assist management in analyzing
and evaluating the ACLs. For example, comparing estimates of expected
credit losses to actual write-offs in aggregate, and by portfolio, may
enable management to assess whether the institution's loss estimation
process is sufficiently designed.\27\ Further, comparing the estimate
of ACLs to actual write-offs at the financial asset portfolio level
allows management to analyze changing portfolio characteristics, such
as the volume of assets or increases in write-off rates, which may
affect future forecast adjustments. Techniques applied in these
instances do not have to be complex to be effective, but, if used,
should be commensurate with the institution's size and complexity.
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\27\ Institutions using models in the loss estimation process
may incorporate a qualitative factor adjustment in the estimate of
expected credit losses to capture the variance between modeled
credit loss expectations and actual historical losses when the model
is still considered predictive and fit for use. Institutions should
monitor this variance, as well as changes to the variance, to
determine if the variance is significant or material enough to
warrant further changes to the model.
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Ratio analysis may also be useful for evaluating the overall
reasonableness of ACLs. Ratio analysis assists in identifying divergent
or emerging trends in the relationship of ACLs to other factors such as
adversely classified or graded loans, past due and nonaccrual loans,
total loans, historical gross write-offs, net write-offs, and historic
delinquency and default trends for securities.
Comparing the institution's ACLs to those of peer institutions may
provide management with limited insight into management's own ACL
estimates. Management should apply caution when performing peer
comparisons as there may be significant differences among peer
institutions in the mix of financial asset portfolios, reasonable and
supportable forecast period assumptions, reversion techniques, the data
used for historical loss information, and other factors.
When used prudently, comparisons of estimated expected losses to
actual write-offs, ratio analysis, and peer comparisons can be helpful
as a supplemental check on the reasonableness of management's
assumptions and analyses. Because appropriate ACLs are institution-
specific estimates, the use of comparisons does not eliminate the need
for a comprehensive analysis of financial asset portfolios and the
factors affecting their collectibility.
When an appropriate expected credit loss framework has been used to
estimate expected credit losses, it is inappropriate for the board of
directors or management to make further adjustments to ACLs for the
sole purpose of reporting ACLs that correspond to a peer group median,
a target ratio, or a budgeted amount. Additionally, neither the board
of directors nor management should further adjust ACLs beyond what has
been appropriately measured and documented in accordance with FASB ASC
Topic 326.
After analyzing ACLs, management should periodically validate the
loss estimation process, and any changes to the process, to confirm
that the process remains appropriate for the institution's size,
complexity, and risk profile. The validation process should include
procedures for review by a party with appropriate knowledge, technical
expertise, and experience who is independent of the institution's
credit approval and ACL estimation processes.
[[Page 33002]]
A party who is independent of these processes could be from internal
audit staff, a risk management unit of the institution independent of
management supervising these processes, or a contracted third-party.
One party need not perform the entire analysis as the validation may be
divided among various independent parties.\28\
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\28\ Engaging the institution's external auditor to perform the
validation process described in this paragraph when the external
auditor also conducts the institution's independent financial
statement audit, may impair the auditor's independence under
applicable auditor independence standards and prevent the auditor
from performing an independent audit of the institution's financial
statements.
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Responsibilities of the Board of Directors
The board of directors, or a committee thereof, is responsible for
overseeing management's significant judgments and estimates used in
determining appropriate ACLs. Evidence of the board of directors'
oversight activities is subject to review by examiners. These
activities should include, but are not limited to:
Retaining experienced and qualified management to oversee
all ACL and PCL activities;
Reviewing and approving the institution's written loss
estimation policies, including any revisions thereto, at least
annually;
Reviewing management's assessment of the loan review
system and management's conclusion and support for whether the system
is sound and appropriate for the institution's size and complexity;
Reviewing management's assessment of the effectiveness of
processes and controls for monitoring the credit quality of the
investment portfolio;
Reviewing management's assessments of and justifications
for the estimated amounts reported each period for the ACLs and the
PCLs;
Requiring management to periodically validate, and, when
appropriate, revise loss estimation methods;
Approving the internal and external audit plans for the
ACLs, as applicable; and
Reviewing any identified audit findings and monitoring
resolution of those items.
Responsibilities of Management
Management is responsible for maintaining ACLs at appropriate
levels and for documenting its analyses in accordance with the concepts
and requirements set forth in GAAP, regulatory reporting requirements,
and this policy statement. Management should evaluate the ACLs reported
on the balance sheet as of the end of each period (and for credit
unions, prior to paying dividends), and debit or credit the related
PCLs to bring the ACLs to an appropriate level as of each reporting
date. The determination of the amounts of the ACLs and the PCLs should
be based on management's current judgments about the credit quality of
the institution's financial assets and should consider known and
expected relevant internal and external factors that significantly
affect collectibility over reasonable and supportable forecast periods
for the institution's financial assets as well as appropriate reversion
techniques applied to periods beyond the reasonable and supportable
forecast periods. Management's evaluations are subject to review by
examiners.
In carrying out its responsibility for maintaining appropriate
ACLs, management should adopt and adhere to written policies and
procedures that are appropriate to the institution's size and the
nature, scope, and risk of its lending and investing activities. These
policies and procedures should address the processes and activities
described in the ``Documentation Standards'' section of this policy
statement.
Management fulfills other responsibilities that aid in the
maintenance of appropriate ACLs. These activities include, but are not
limited to:
Establishing and maintaining appropriate governance
activities for the loss estimation process(es). These activities may
include reviewing and challenging the assumptions used in estimating
expected credit losses and designing and executing effective internal
controls over the credit loss estimation method(s);
Periodically performing procedures that compare credit
loss estimates to actual write-offs, at the portfolio level and in
aggregate, to confirm that amounts recorded in the ACLs were sufficient
to cover actual credit losses. This analysis supports that appropriate
ACLs were recorded and provides insight into the loss estimation
process's ability to estimate expected credit losses. This analysis is
not intended to reflect the accuracy of management's economic
forecasts;
Periodically validating the loss estimation process(es),
including changes, if any, to confirm it is appropriate for the
institution; and
Engaging in sound risk management of third parties
involved \29\ in ACL estimation process(es), if applicable, to ensure
that the loss estimation processes are commensurate with the level of
risk, the complexity of the third-party relationship and the
institution's organizational structure.
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\29\ Guidance on third party service providers may be found in
SR Letter 13-19/Consumer Affairs Letter 13-21, Guidance on Managing
Outsourcing Risk (FRB); Financial Institution Letter (FIL) 44-2008,
Guidance for Managing Third Party Risk (FDIC); Supervisory Letter
No. 07-01, Evaluating Third Party Relationships (NCUA); and OCC
Bulletin 2013-29, Third Party Relationships: Risk Management
Guidance, OCC Bulletin 2017-7, Third Party Relationships:
Supplemental Examination Procedures, and OCC Bulletin 2017-21, Third
Party Relationships: Frequently Asked Questions to Supplement OCC
Bulletin 2013-29.
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Additionally, if an institution uses loss estimation models in
determining expected credit losses, management should evaluate the
models before they are employed and modify the model logic and
assumptions, as needed, to help ensure that the resulting loss
estimates are consistent with GAAP and regulatory reporting
requirements.\30\ To demonstrate such consistency, management should
document its evaluations and conclusions regarding the appropriateness
of estimating credit losses with models. When used for multiple
purposes within an institution, models should be specifically adjusted
and validated for use in ACL loss estimation processes. Management
should document and support any adjustments made to the models, the
outputs of the models, and compensating controls applied in determining
the estimated expected credit losses.
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\30\ See the interagency statement titled, Supervisory Guidance
on Model Risk Management, published by the Board in SR Letter 11-7
and OCC Bulletin 2011-12 on April 4, 2011. The statement also
addresses the incorporation of vendor products into an institution's
model risk management framework following the same principles
relevant to in-house models. The FDIC adopted the interagency
statement on June 7, 2017. Institutions supervised by the FDIC
should refer to FIL-22-2017, Adoption of Supervisory Guidance on
Model Risk Management, including the statement of applicability in
the FIL.
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Examiner Review of ACLs
Examiners are expected to assess the appropriateness of
management's loss estimation processes and the appropriateness of the
institution's ACL balances as part of their supervisory activities. The
review of ACLs, including the depth of the examiner's assessment,
should be commensurate with the institution's size, complexity, and
risk profile. As part of their supervisory activities, examiners
generally assess the credit quality and credit risk of an institution's
financial asset portfolios, the adequacy of the institution's credit
loss estimation processes, the adequacy of supporting
[[Page 33003]]
documentation, and the appropriateness of the reported ACLs and PCLs in
the institution's regulatory reports and financial statements, if
applicable. Examiners may consider the significant factors that affect
collectibility, including the value of collateral securing financial
assets and any other repayment sources. Supervisory activities may
include evaluating management's effectiveness in assessing credit risk
for debt securities (both prior to purchase and on an on-going basis).
In reviewing the appropriateness of an institution's ACLs, examiners
may:
Evaluate the institution's ACL policies and procedures and
assess the loss estimation method(s) used to arrive at overall
estimates of ACLs, including the documentation supporting the
reasonableness of management's assumptions, valuations, and judgments.
Supporting activities may include, but, are not limited to:
[cir] Evaluating whether management has appropriately considered
historical loss information, current conditions, and reasonable and
supportable forecasts, including significant qualitative factors that
affect the collectibility of the financial asset portfolios;
[cir] Assessing loss estimation techniques, including loss
estimation models, if applicable, as well as the incorporation of
qualitative adjustments to determine whether the resulting estimates of
expected credit losses are in conformity with GAAP and regulatory
reporting requirements; and
[cir] Evaluating the adequacy of the documentation and the
effectiveness of the controls used to support the measurement of the
ACLs;
Assess the effectiveness of board oversight as well as
management's effectiveness in identifying, measuring, monitoring, and
controlling credit risk. This may include, but is not limited to, a
review of underwriting standards and practices, portfolio composition
and trends, credit risk review functions, risk rating systems, credit
administration practices, investment securities management practices,
and related management information systems and reports;
Review the appropriateness and reasonableness of the
overall level of the ACLs relative to the level of credit risk, the
complexity of the institution's financial asset portfolios, and
available information relevant to assessing collectibility, including
consideration of current conditions and reasonable and supportable
forecasts. Examiners may include a quantitative analysis (e.g., using
management's results comparing expected write-offs to actual write-offs
as well as ratio analysis) to assess the appropriateness of the ACLs.
This quantitative analysis may be used to determine the reasonableness
of management's assumptions, valuations, and judgments and understand
variances between actual and estimated credit losses. Loss estimates
that are consistently and materially over or under predicting actual
losses may indicate a weakness in the loss forecasting process;
Review the ACLs reported in the institution's regulatory
reports and in any financial statements and other key financial reports
to determine whether the reported amounts reconcile to the
institution's estimate of the ACLs. The consolidated loss estimates
determined by the institution's loss estimation method(s) should be
consistent with the final ACLs reported in its regulatory reports and
financial statements, if applicable;
Verify that models used in the loss estimation process, if
any, are subject to initial and ongoing validation activities.
Validation activities include evaluating and concluding on the
conceptual soundness of the model, including developmental evidence,
performing ongoing monitoring activities, including process
verification and benchmarking, and analyzing model output.\31\
Examiners may review model validation findings, management's response
to those findings, and applicable action plans to remediate any
concerns, if applicable. Examiners may also assess the adequacy of the
institution's processes to implement changes in a timely manner; and
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\31\ See footnote 30.
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Review the effectiveness of the institution's third-party
risk management framework associated with the estimation of ACLs, if
applicable, to assess whether the processes are commensurate with the
level of risk, the complexity and nature of the relationship, and the
institution's organizational structure. Examiners may determine whether
management monitors material risks and deficiencies in third-party
relationships, and takes appropriate action as needed.\32\
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\32\ See footnote 29.
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When assessing the appropriateness of ACLs, examiners should
recognize that the processes, loss estimation methods, and underlying
assumptions an institution uses to calculate ACLs require the exercise
of a substantial degree of management judgment. Even when an
institution maintains sound procedures, controls, and monitoring
activities, an estimate of expected credit losses is not a single
precise amount and may result in a range of acceptable outcomes for
these estimates. This is a result of the flexibility FASB ASC Topic 326
provides institutions in selecting loss estimation methods and the wide
range of qualitative and forecasting factors that are considered.
Management's ability to estimate expected credit losses should
improve over the contractual term of financial assets as substantive
information accumulates regarding the factors affecting repayment
prospects. Examiners generally should accept an institution's ACL
estimates and not seek adjustments to the ACLs, when management has
provided adequate support for the loss estimation process employed, and
the ACL balances and the assumptions used in the ACL estimates are in
accordance with GAAP and regulatory reporting requirements. It is
inappropriate for examiners to seek adjustments to ACLs for the sole
purpose of achieving ACL levels that correspond to a peer group median,
a target ratio, or a benchmark amount when management has used an
appropriate expected credit loss framework to estimate expected credit
losses.
If the examiner concludes that an institution's reported ACLs are
not appropriate or determines that its ACL evaluation processes or loss
estimation method(s) are otherwise deficient, these concerns should be
noted in the report of examination and communicated to the board of
directors and senior management.\33\ Additional supervisory action may
be taken based on the magnitude of the shortcomings in ACLs, including
the materiality of any errors in the reported amounts of ACLs.
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\33\ Each agency has formal and informal communication channels
for sharing supervisory information with the board of directors and
management depending on agency practices and the nature of the
information being shared. These channels may include, but are not
limited to, institution specific supervisory letters, letters to the
industry, transmittal letters, visitation findings summary letters,
targeted review conclusion letters, or official examination or
inspection reports.
Joseph M. Otting,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System.
Ann Misback,
Secretary of the Board.
Federal Deposit Insurance Corporation.
By order of the Board of Directors.
[[Page 33004]]
Dated at Washington, DC, on February 20, 2020.
Robert E. Feldman,
Executive Secretary.
By the National Credit Union Administration Board.
Gerard Poliquin,
Secretary of the Board.
[FR Doc. 2020-10291 Filed 5-29-20; 8:45 am]
BILLING CODE 4810-33-P; 6210-01-P; 6714-01-P; 7535-01-P