thoughtware financial servicesservices thoughtware® cecl & business ... transition accounting...

12/5/2018

1

Financial Services

THOUGHTWARE®

CECL & Business Combinations

December 5, 2018

THOUGHTWARE®

Nancy J. ForingerABV, ASA-BV/IAManaging DirectorForensics & Valuation ServicesKansas City

John Hemmer, CPADirectorOmaha

12/5/2018

2

To Receive CPE Credit

Individuals• Participate in entire webinar

• Answer polls when they are provided

Groups• Group leader is the person who registered & logged on to the webinar

• Answer polls when they are provided

• Complete group attendance form

• Group leader sign bottom of form

• Submit group attendance form to [email protected] within 24 hours of webinar

• If all eligibility requirements are met, each participant will be emailed their

CPE certificate within 15 business days of webinar



• Will you have any remaining acquired loans upon transition to CECL?

• Do you plan to make acquisitions subsequent to CECL implementation?


CECL Effective Dates*

2020 2021 2022

SEC Filers PBEs-Non SEC Filers Non-Public

*Annual & interim periods

12/5/2018

3



Business Combinations: Current Practice• Day 1 ASC 805 Loan Portfolio Valuation• Day 2 Purchase Accounting• Allowance – Incurred Loss

Business Combinations: CECL• New definitions – PCD & Non-PCD• Day 1 ASC 805 Loan Portfolio Valuation• Day 2 Purchase Accounting• Allowance – Expected Credit Loss

Transition Accounting

Business Combinations: Current Practice

• Day 1 ASC 805 Valuation of Loan Portfolio

• Day 2 Purchase Accounting

• ASC 310-20

• ASC 310-30 (PCI)

• Allowance – Incurred Loss Model


12/5/2018

4

Current Practice: Day 1 ASC 805

• ASC 820 – Market Participant “Exit Price” (not Topic 326)

• Interest & Credit Components

• Discounted Cash Flows

• Prepayment Assumptions

• CECL Is Not Fair Value


ASC 820 CECL

Includes market interest rate Does not consider market rate

Expected credit losses – market participant assumptions Expected credit losses – entity specific assumptions

Prepayments considered Prepayments considered

Discounted cash flow method used to determine FV Does not require a DCF method to determine allowance

Business Combinations: Day 1 ASC 805

After CECL is implemented, there is the potential for three estimates of expected credit loss on a loan or portfolio on the same measurement date

• Target institution ECL Allowance using their data & methodologies

• ASC 805 market participant ECL prepared by a Specialist

• Acquiring institution ECL Allowance using their data & methodologies


12/5/2018

5


• Day 2 Purchase Accounting: ASC 310-20

• Not impaired

• Credit & Yield discount/premium from Day 1 are combined & accreted over the remaining life of the loan on a level yield basis (typically)

• Uploaded to core to maintain future accounting (typically)



• Day 2 Purchase Accounting: ASC 310-30

• Purchase Credit Impaired (PCI)

• Nonaccretable & accretable balances are remeasured on a periodic basis subsequent to Day 1 through life of loans/pools

• Usually maintained on spreadsheets or third-party vendor


12/5/2018

6

Current Practice: ALLL

• Allowance for Loan Losses – Incurred Model

• ASC 310-20 loans – evaluated periodically & a provision is made if losses expected to differ from recorded net balance under Day 2 purchase accounting

• ASC 310-30 loans – evaluated periodically & a provision is made if losses expected to exceed remaining nonaccretable balance


Business Combinations: CECL

• New definitions – PCD & Non-PCD

• Day 1 ASC 805 Loan Portfolio Valuation

• Day 2 Purchase Accounting

• Allowance – Expected Credit Loss


12/5/2018

7

Business Combinations: PCD

PCI

Purchased Financial Assets with Credit Deterioration (PCD)

Acquired individual financial assets (or groups of financial assets with similar risk characteristics) that as of the date of acquisition have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by an acquirer’s assessment. (emphasis added)

ASU 2016-13 Glossary



Some Factors for Assessment of PCD Assets (326-20-55-59)

Financial assets that are delinquent as of the acquisition date

Financial assets that have been downgraded since origination

Financial assets that have been placed on nonaccrual status

Financial assets for which, after origination, credit spreads have widened beyond the threshold specified in its policy


12/5/2018

8



And More

326-20-55-60

Judgment is required when determining whether purchased

financial assets should be recorded as purchased financial assets with credit deterioration. There may be other acceptable considerations &

policies applied by an entity to identify PCD assets.



• Generally expected that more acquired loans will meet the definition of PCD versus prior PCI definition

• Does not mean that all loans acquired with a purchase discount will meet definition of PCD

PCD is not just the new PCI

12/5/2018

9



• Determination may be made at individual or group level if similar risk characteristics exist (326-20-55-5)

• Requires entity’s development & documentation of policies related to assessment of determination of PCD assets for consistency



• Why does it matter?

• There is a big difference in the accounting treatment for PCD vs. non-PCD assets

12/5/2018

10

Business Combinations: PCD vs. Non-PCD

PCD Loans

(326-20-30-13)

• Allowance added to the purchase price to determine the initial amortized cost basis

• “Gross Up”

Non-PCD Loans

(326-20-30-15 & 805-20-30-4A)

• Allowance accounted for in a manner consistent with originated assets

• Not permitted to net any purchase discount with the allowance

• “Double Count”


Business Combinations: CECL-PCD Loans

• Fair Value is the purchase price. Includes an interest component & a credit component measured at acquisition under ASC 805

• Allowance for expected credit losses is calculated by the acquirer at acquisition under ASC 326 & adds this amount to the fair value (grosses up) to calculated amortized cost

• Noncredit component is accreted on a level yield basis at EIR


PCD: Amortized Cost

Fair Value (Market Participant) Interest Component Credit Component

Allowance (Acquirer) PLUS: Expected Credit Loss

12/5/2018

11


• Day 1: Example 13 (No DCF)


Purchase Price 1,918,559 Acquirer loss rate 10%Acquirer allowance 217,620 Default Year 5

Day 1 EntryLoan 2,176,204 A

Loan-noncredit discount 40,025 A-B-C

Allowance for credit losses 217,620 C

Cash 1,918,559 B

Amortized cost 2,136,179 B+C

Effective interest rate 7.33% solved to amort cost using contractual payment/term


• Day 2

• Noncredit Accretion

• Allowance rollforward

Note: assumes no change in ECL. Example 13.


Loan Principal Bal 2,176,204 Purchase Price 1,918,559 Amortized Cost 2,136,179 Allowance 217,620

Day 2 Accretion (noncredit)*Year 1 26,103 Year 2 13,921

40,025

Day 2 Charge-offYear 1 - Year 2 217,620 Allowance rollforwardYear 1 Beg 217,620 Plus expense - less charge offs - Year 1 Ending 217,620 Amortized Cost 2,136,179

Year 2 Beg 217,620 Plus expense - less charge offs (217,620) Year 2 Ending -

12/5/2018

12

Business Combinations: CECL – Non-PCD Loans

Non-PCD Amortized Cost

Fair Value (Market Participant) Credit Component Interest Component


Acquirer - Day 110,000,000 Principal Balance

- Accrued fees and interest (do not carry over)

9,750,000 Fair Value (ASC 805)Market Participant (175,000) Credit Component (accreted to income over time)

(75,000) Non-Credit Component (accreted to income over time)

9,750,000 Amortized CostAcquirer Mgmt (175,000) Allowance

9,575,000 Carrying value

Business Combinations: CECL – Non-PCD Loans

Acquirer - Day 2

Valuation Discount* Allowance Net Income(225,000) (175,000) (400,000)

Year 1 75,000 - 75,000 Balance (150,000) (175,000) (325,000)

Year 2 75,000 100,000 175,000 Balance (75,000) (75,000) (150,000)

Year 3 75,000 75,000 150,000 Balance - - -

* ratable over three years for illustration purposes


12/5/2018

13

Business Combinations: Summary Comparison

Acquirer - Day 2Non-PCD

Valuation Discount* Allowance Net IncomeBalance (225,000) (175,000) (400,000)

Year 1 75,000 - 75,000 Balance (150,000) (175,000) (325,000)

Year 2 75,000 100,000 175,000 Balance (75,000) (75,000) (150,000)

Year 3 75,000 75,000 150,000 Balance - - -

* ratable over three years for illustration purposes

PCD (Example 13)Valuation Discount Allowance Net Income

Balance (40,025) (217,620) (257,645) Year 1 26,103 - 26,103

Balance (13,922) (217,620) (231,542) Year 2 13,922 217,620 231,542

Balance - - -



There will likely be more volatility introduced in the financial statements under CECL, especially for institutions that are acquisitive depending on the mix of PCD & non-PCD loans

• PCD – less accretion related to valuation discount (noncredit only)

• Non-PCD – higher accretion related to valuation discount (both interest & credit mark)


12/5/2018

14

Business Combinations: Summary Comparison


PCD Non-PCD

Day 1 Day 2 Day 1 Day 2

Principal Balance Principal Balance

Less/Plus: Interest Component Do not accrete Less/Plus: Interest Component Accrete

Less: Credit Component Do not accrete Less: Credit Component Accrete

Equals: Fair Value Equals: Fair Value

Plus: Allowance Remeasure Equals: Amortized Cost

Equals: Amortized Cost Less: Allowance Remeasure

Equals: Carrying Value Equals: Carrying Value

Difference between carrying value/amortized cost & fair value is

noncredit component

Accrete


Recording an ECL upon acquisition of non-PCD loans has the potential to improve comparability among institutions. Currently, banks with a large portion of the portfolio from acquisitions have a lower allowance than banks with originated loans, making it difficult to compare reserve balances across institutions.


12/5/2018

15

CECL Measurement

• Portion of the amortized cost basis of a financial asset that an entity does not expect to collect – “Net amount expected to be collected”

• Expected credit losses (ECL) measured over the loan’s contractual term

• Current economic conditions & management’s expectations of future economic conditions that are reasonable & supportable


CECL Measurement


• Unpaid Principal Balance• Accrued Interest• Premiums/Discounts• Net Deferred Fees/Costs• Write-Offs• Foreign Exchange

Amortized Cost

12/5/2018

16

CECL Measurement

• Flexibility to select from various methods

• Loss-rate methods

• Vintage

• Roll-rate methods

• DCF

• PD/LGD


CECL Measurement: Method Comparison


DCF

• ECL discounted at EIR• Allowance = difference between

amortized cost & PV of expected cash flows

• ECL may change due to time value & timing & amount of expected future cash flows

Non-DCF

• ECL is not discounted• Not affected by timing &

amount of expected cash flows or by time value

12/5/2018

17


Using a DCF method generally results in an initial lower credit expense for the allowance but higher accretion expense in future periods


CECL Impact to Net Income

When a DCF Method Is Used

• Entire change in PV recorded as credit loss expense (326-20-45-3)

OR

• Change in PV related to time value component may be recorded as interest income (326-20-50-12)


12/5/2018

18

Transition Accounting: PCI Loans

• Existing PCI loans• PCI loans will become PCD loans upon implementation of CECL OR

• Can make accounting policy election to maintain pool of PCI loans under ASC 310-30 (June 2017 TRG meeting)

• Do not reassess whether previously acquired PCI loans meet the definition of PCD loans

• Do not move non-PCI loans to PCD; keep pools of non-PCI & PCI the same from previous acquisitions

• If system (or manual tracking) has capabilities, will be beneficial to tag which loans are previously acquired PCI loans


Transition Accounting: PCI Loans

• Existing PCI loans

• Apply the new PCD asset gross-up at transition to all PCI loans now included as PCD

• Change in ALLL under CECL is an adjustment to the amortized cost basis

• It is not part of the cumulative-effect one-time adjustment


12/5/2018

19

Transition Accounting: PCI/PCD Modifications

• DO NOT reassess on adoption date if prior PCI modifications constitute a TDR classification

• After CECL is adopted PCD modifications must be evaluated to determine if they are TDRs

• If maintain PCI loan pools revert back to old TDR rules of ASC 310-30


Transition Accounting: Non-PCI Loans

• Existing non-PCI acquired portfolio remains as non-PCI

• Non-PCI loans will continue to accrete the valuation adjustment as they do currently

• Allowance accounted for in a manner consistent with originated assets

• Initial impact recorded as part of retained earnings adjustment


12/5/2018

20

Transition Accounting

As many do currently, it may be helpful to code acquired loans by acquisition to facilitate measurement of ECL


Summary

• Key differences in accounting for loans acquired under ASC 326 versus today

• Impacts to income statement & capital

• Planning for transition


12/5/2018

21

Continuing Professional Education (CPE) Credit

BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.nasbaregistry.org.

The information contained in these slides is presented by professionals for your information only & is not to be considered as legal advice. Applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor or legal counsel before acting on any matters covered.

12/5/2018

22

To Receive CPE Credit

• CPE credit may be awarded upon verification of participant attendance

• For questions, concerns or comments regarding CPE credit, please email the BKD Learning & Development Department at [email protected]

bkd.com/FS | @BKDFS

thoughtware financial servicesservices thoughtware® cecl & business ... transition accounting...

Documents