CECL Blog Series – #6
This blog was authored by my colleague, Mike Baas, a Director in our financial institutions practice in Toledo, Ohio.
Welcome back to the CLA CECL Blog Series. As a reminder, over the past few months, CLA has taken a deep dive into many of the hot topics surrounding the Current Expected Credit Loss (CECL) standard. In this blog, we’ll discuss the CECL impact on Available for Sale and Held to Maturity debt securities. In the event you weren’t able to attend our webinar on October 28, 2021, you can view the recording of the webinar here. Make sure you receive our invitations by signing up for CLA communications here. We hope you find great value in this blog series and welcome the interaction with any of the authors.
CECL Impact on HTM and AFS Debt Securities
As discussed in our previous CECL blogs, ASU 2016-13 Financial Instruments – Credit Losses (ASC Topic 326) (CECL) presents a significant change to the way financial institutions estimate credit losses in the loan portfolio. Implementation planning needs to consider other assets that are carried at amortized cost such as Held to Maturity (HTM) debt securities. Even though Available for Sale (AFS) debt securities are reported at fair value, CECL implementation still requires changes to the accounting for these securities.
Held to Maturity Securities
HTM debt securities are carried at amortized cost, and within the scope of CECL. Upon implementation, an allowance for credit loss may need to be recorded for HTM debt securities. An allowance for credit loss for HTM debt securities methodology needs to group securities with similar risk profiles into pools to be evaluated collectively. It is required to consider historic data, current condition, and reasonable and foreseeable forecasts. The allowance will require periodic evaluation to be maintained with the same frequency as your shortest external reporting period. Essentially HTM debt securities are evaluated just like how your institution evaluates its loan portfolio.
Available for Sale Securities
It is important to understand that although the changes to AFS debt securities is implemented with CECL, the AFS debt security impairment and credit losses evaluation is excluded from the CECL subtopic and codified within its own subtopic, ASC 326-30. Similar to financial institution’s current practice of evaluating Available for Sale (AFS) debt securities on an individual security basis for other-than-temporary impairment AFS debt securities will be evaluated individually, and the concepts of “intend to sell” and “more-likely-than-not required to sell” of the current standard remain. However, it is important to understand the differences when developing policies.
Currently, credit losses are recognized as a direct write down to amortized cost that cannot be immediately reversed. Under the new guidance, credit losses are recognized in an allowance for credit loss determined on an individual security basis and is measured as the difference between the security’s amortized cost basis and the amount expected to be collected over the security’s lifetime. The allowance can be partially or fully reversed in the future. The new guidance limits the allowance for credit loss to the difference between the fair value of the security and its amortized cost.
Additionally, current guidance considers the volatility of the fair value of the security and the length of time a security has been in an unrealized loss position when determining if an impairment is other than temporary. These concepts do not exist when determine if an allowance for credit loss is warranted under the new guidance. The concept of if a company intends to sell, or more likely than not will be required to sell the AFS debt security comes into play when determining how much of the difference between fair value and amortized cost will be recorded into income versus other comprehensive income. It is important to remember these differences when updating significant accounting policies.
Equity Securities
There is no CECL impact on equity securities as the securities are marked to fair value through the income statement for each reporting period.
How can we help?
Regardless of where your institution is at on your CECL journey, CLA is prepared to assist your institution in any way we can. Throughout this blog series or at any time, contact us with your questions. We look forward to being a resource for your institution as you navigate the implementation process!
Joshua Juergensen is a principal with CLA. He works with banks and credit unions nationwide, managing audit engagements, directors’ exams, external loan file reviews, internal audits, and other consulting services.
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