Posted: November 28th, 2014

Bank Loan Loss Accounting

Bank Loan Loss Accounting

Department of Accounting
Mihaylo College of Business and Economics
California State University, Fullerton
Accounting 301A
Intermediate Accounting I

Fall 2014
Bank Loan Loss Accounting Research Paper
Upload to Turnitin.com before the start of the last section’s class meeting: Tuesday, December 9, 2014.  Submit a printed copy of your paper at the start of your class meeting.  Use 14-point font.
Focus
The focus of your research is on the proposed changes in accounting standards for bank loan loss accounting.

Your research paper must be a paper an accounting professional would write.  You must include, in your own words, explanations of accounting standards.  Your paper must NOT be a collection of summaries of articles in the popular media written by non-accountants.  Do not use Wikipedia or mass audience newspapers, magazines, or web sites.  Use corporate filings with the Securities and Exchange Commission (SEC), academic journal articles, articles by financial analysts, and other high-quality sources of information.
Background Readings
The following are a small sample of articles related to your research topic.  These articles will help you to find the appropriate disclosures in bank filings.
Proposed Accounting Change Could Catch Lenders Unprepared
Results Released as Part of New Bank Executive Survey
By
Michael Rapoport
Updated Aug. 12, 2014 4:22 p.m. ET
A proposed accounting change expected to force banks to boost the amount of reserves they hold against soured loans could catch many small and midsize lenders unprepared, according to a new survey of bank executives.
More than half of the executives familiar with the Financial Accounting Standards Board’s expected changes said they aren’t planning to make significant modifications in their processes to cope with the changes until after they’re completed, according to the survey from Sageworks, a financial-information company.
More than a third of the executives surveyed have little or no familiarity with the changes that FASB, which sets accounting rules for U.S. companies, hopes to finalize before the end of the year, according to the survey.
The changes would require banks to book loan losses much more quickly than they do now and force them to dramatically increase their loan-loss reserves.
Banks have some time to adapt. The expected FASB changes likely won’t take effect until 2017 or 2018.
But banks should start preparing now because they’ll need to amass a lot of data on their loans’ performance to cope with the changes, and to make changes in their processes to store and use that data, Sageworks said. If they don’t, the company said, the banks might not be able to assess and reserve for their loan losses as accurately.
With the changes, banks are “going to need a lot more granular data for individual loans,” perhaps three or four years’ worth of performance data, said Libby Bierman, a Sageworks analyst. “To get that data, banks need to start today.”
There are “good reasons” many banks aren’t yet prepared, said Donna Fisher, senior vice president of tax and accounting for the American Bankers Association. Notably, FASB has yet to make some decisions that could affect the final form of its new loan-accounting model, and the board needs to make sure all banks are on the same page in understanding what will be required of them, she said.
Also, “a lot of bankers are not focused on it,” said James Kendrick, vice president of accounting and capital policy for the Independent Community Bankers of America. So much is happening now in banking regulation that banks have to address that many aren’t paying much attention yet to the loan-accounting changes, he said.
Christine Klimek, a FASB spokeswoman, said the board is “considering the feedback” it’s received in response to its loan-accounting proposal, and “will give banks and other lending institutions sufficient time to incorporate the changes.”
lFASB’s changes, which the board has proposed and is working toward competing, are expected to require banks to record losses based on their future projections of loans going bad. Currently, banks don’t book loan losses until the losses have actually occurred, an approach many observers think led banks to be too slow in taking losses during the financial crisis. Under the new rule, banks will have to record upfront all losses expected over the lifetime of a loan.
The new method is expected to speed up the booking of losses and require banks to boost their loan-loss reserves significantly, possibly by as much as 50%, according to FASB and some industry estimates.
Global accounting rule-makers at the International Accounting Standards Board already have enacted a similar change for banks outside the U.S., beginning in 2018.
The IASB rule is softer, however, requiring to book upfront only those losses based on the probability that a loan will default in the next 12 months, not all lifetime losses.
The survey, conducted for Sageworks by SourceMedia Research, polled 236 managers who deal with credit-risk management at banks and credit unions with between $250 million and $5 billion in assets. Of those surveyed, 37% had little or no familiarity with FASB’s planned changes, though the proposal has been in the works and much-publicized over the past few years.
Sixty-five percent of those surveyed use spreadsheets to calculate their loan-loss reserves, as opposed to external or proprietary software or other methods. But Sageworks says that may not be sufficient to handle the massive amount of data banks will have to collect to accurately predict future losses under the new model, and many banks aren’t yet acting to update their processes.
Of those surveyed, 34% plan to acquire new software to comply with the new requirements when they’re completed. Another 21% say they’ll acquire new software before the new model is enforced. Most of the other respondents either already have new software or don’t know when they will acquire it.
Write to Michael Rapoport at [email protected]
http://online.wsj.com/articles/proposed-accounting-change-could-catch-lenders-unprepared-1407868666
SEC Announces Fraud Charges Against Three Former Regions Bank Executives in Accounting Scheme
FOR IMMEDIATE RELEASE
2014-125
Washington D.C., June 25, 2014 —
The Securities and Exchange Commission today announced fraud charges against three former senior managers of Regions Bank for intentionally misclassifying loans that should have been recorded as impaired for accounting purposes.  As a result, the bank’s publicly-traded holding company overstated its income and earnings per share in its financial reporting.
The SEC also entered into a deferred prosecution agreement with Regions Financial Corp., which substantially cooperated with the agency’s investigation and undertook extensive remedial actions.  Regions will pay a total of $51 million to resolve parallel actions by the SEC, Federal Reserve Board, and Alabama Department of Banking.
According to the SEC’s orders instituting administrative proceedings against the three former managers, Thomas A. Neely Jr. was the principal architect of the scheme while serving as head of Regions Bank’s risk analytics group in 2009.  Along with the bank’s head of special assets Jeffrey C. Kuehr and chief credit officer Michael J. Willoughby, Neely took intentional steps to circumvent internal accounting controls and improperly classify $168 million in commercial loans as performing so Regions could avoid recording a higher allowance for loan and lease losses.
Kuehr and Willoughby agreed to settle the SEC’s charges by paying penalties of $70,000 apiece and consenting to bars from serving as officers or directors of public companies.  The SEC’s Division of Enforcement will continue to litigate its case against Neely.
“Our enforcement actions against three senior executives coupled with the deferred prosecution agreement with Regions demonstrate that we will aggressively pursue individual responsibility while rewarding extraordinary cooperation and remediation by companies,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement.  “The bank helped us bring a case against culpable individuals while remediating the misconduct by restructuring its processes and putting new management in place, among other things.”
According to the SEC’s orders and the deferred prosecution agreement, Regions Bank tracked and recorded its non-performing loans (NPLs) for internal performance metrics and regular financial reporting.  NPLs typically were placed on non-accrual status when it was determined that payment of all contractual principal and interest was 90 days past due or otherwise in doubt.  Once a loan was placed in non-accrual status, uncollected interest accrued during that current year was reversed and Regions Bank’s interest income would be reduced.  Non-accrual status also served as a trigger for Regions Bank to consider whether the specific loan was impaired and to determine an allowance for loan and lease losses in accordance with U.S. Generally Accepted Accounting Principles (GAAP).
The SEC’s Division of Enforcement alleges that when personnel within Regions Bank’s special asset department initiated procedures to place approximately $168 million in NPLs into non-accrual status during the first quarter of 2009, Neely arbitrarily and without supporting documentation required the loans to remain in accrual status.  By failing to classify the impaired loans in accordance with its policies, Regions’ financial statements for the quarter ended March 31, 2009, were materially misstated and not in conformity with GAAP.  In furtherance of the scheme, Neely and Willoughby knowingly provided understated NPL data for the quarter to the Regions’ CFO and other senior executives during a meeting in late March.
The SEC’s order against Neely charges him with violations of the antifraud, reporting, books and records, and internal controls provisions of the federal securities laws.  Kuehr and Willoughby consented to the entry of a cease-and-desist order finding that they violated or caused violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 as well as the reporting, books and records, and internal controls provisions of the federal securities laws.  Without admitting or denying the findings, Kuehr and Willoughby agreed to pay their respective $70,000 penalties plus be prohibited from serving as officers or directors of public companies for a period of five years.
The deferred prosecution agreement with Regions relates to the bank’s failure to maintain adequate accounting controls at the time.  The agreement credits the company’s extensive remedial efforts, including the creation of a new problem asset division with entirely new management and significantly enhanced procedures.  The agreement credits the substantial cooperation by Regions during the SEC’s investigation, and imposes a $26 million penalty that will be offset provided that the company pays a $46 million penalty assessed in the Federal Reserve’s action.  Regions also will pay a $5 million penalty to the Alabama Department of Banking.
The SEC’s investigation was conducted in its Atlanta Regional Office.  The SEC appreciates the assistance of the Federal Reserve.
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542168845#.VAFK42OV098
Big Banks Are Padding Profits With ‘Reserve’ Cash
As Revenue Slows, Some Banks Increasingly Use Loan-Loss Reserves to Boost Income
By
Michael Rapoport
Updated Oct. 25, 2013 7:23 p.m. ET
Federal regulators have warned banks to be careful about padding their profits with money set aside to cover bad loans. But some of the nation’s biggest banks did more of it in the third quarter than earlier this year.

J.P. Morgan Chase & Co., Wells Fargo & Co., Bank of America Corp. and Citigroup Inc., the nation’s largest banks by assets, tapped a total of $4.9 billion in loan-loss reserves in the third quarter, up by about a third from both the second quarter and the year-ago quarter after adjustments. All the banks except Citigroup showed significant increases compared with the second quarter.
Accounting rules allow the money to flow directly into profits. In all, it made up 18% of the banks’ third-quarter pretax income excluding special items, the highest percentage in a year, according to an analysis by The Wall Street Journal.
The moves come at a time when banks are being slammed by revenue slowdowns. Big commercial banks have suffered from a double whammy of plunging mortgage lending and trading activity. Third-quarter revenue for the four banks dropped an average of 8% from the previous quarter. The KBW Bank Index has declined 2% in the past three months, while the S&P 500 stock index has gained 4% over the same period.
The accounting maneuvers show how banks can prop up earnings when business hits a rough patch.
“You’ve seen reserve releases improve the stated numbers,” said Justin Fuller, a Fitch Ratings analyst. “Going forward, I think there’s fewer levers to pull for the banks.”
Investment banks are feeling the squeeze as well. Goldman Sachs Group Inc. cut the funds it set aside for compensation in the third quarter, a move that bolstered its results in the face of a 20% revenue decline from the same quarter a year earlier.
Such moves are “very emblematic of what’s going on,” said Charles Peabody, partner in charge of research at Portales Partners LLC, a financial-services research firm. The degree to which the banks’ earnings rely on loan-loss reserves “exposes the lack of growth” in their traditional businesses, he said.
The banks justify the releases. They cite improvements in credit quality and economic conditions—which make it less necessary for them to hold large amounts of reserves as a cushion against loans that go sour—and they say they are following accounting rules that require them to release funds as losses ease.
A Bank of America spokesman said “the significant impact in credit quality we’ve seen in the last 12 months” has driven the reserve releases. J.P. Morgan, Wells Fargo and Citigroup all pointed to previous comments their top executives recently made indicating that reserve releases were merited because of factors like improving credit quality and the recent increase in housing prices.
But the Office of the Comptroller of the Currency, which regulates nationally chartered banks and federal savings associations, is reiterating warnings to banks about overdoing it.
In a statement to the Journal, Comptroller Thomas Curry said the OCC is monitoring banks’ loan-loss allowances “very closely” and that “we continue to caution banks not to move too quickly to reduce reserves or become too dependent on these unsustainable releases.” He didn’t comment specifically on the banks’ third-quarter releases, but said OCC examiners “will continue to challenge allowances on a bank-by-bank basis if necessary.”
If the regulator finds problems with a bank’s reserves, it can issue a “matter requiring attention,” a specific finding of a deficiency that a bank must address, an OCC spokesman said. The agency has thousands of such findings outstanding on a variety of subjects, but the OCC spokesman wouldn’t say how many, if any, were related to banks’ reserve releases.
Mr. Curry has been vocal on the issue for more than a year. In September 2012, he called it a “matter of great concern,” warning banks that “too much of the increase in reported profits is being driven by loan-loss-reserve releases.”
Last month, Mr. Curry said in a speech that when economic growth is slow, as it is now, banks might take more risks to maximize their returns, and so it is “particularly important” they maintain appropriate reserves. While some level of reserve releases is “certainly warranted,” he said, the ease of boosting earnings through the practice “has proved habit-forming” at some banks, though he didn’t single out any specific institutions.
Mr. Curry said his previous concerns initially seemed to get banks’ attention, and reserve releases temporarily eased, but that was “an anomaly.” Since then, he said, the releases have increased again, despite “loosening credit underwriting standards” that suggest banks are facing higher risks.
The OCC isn’t alone in its concern. Last year, Federal Deposit Insurance Corp. Chairman Martin Gruenberg said the trend of earnings driven by lower loan-loss provisions “cannot go on forever.” An FDIC spokesman said Friday, “We will continue to evaluate and confirm the ongoing adequacy of reserves during our regular examinations.”
Other banks are releasing reserves, as well, though the amounts drop off drastically below the top four. In the second quarter, the most-recent period for which industrywide figures are available, nearly 40% of all FDIC-insured banks released reserves, according to the FDIC. As of June 30, the industry’s bad-loan reserves had fallen to their lowest level as a percentage of total loans since before the financial crisis began, according to FDIC data.
J.P. Morgan released $1.8 billion in the third quarter, including $1.6 billion from its consumer and community banking unit, accounting for 19% of its pretax income after the bank’s giant litigation expenses in the quarter are excluded. That is higher than in recent quarters, though the bank’s nonperforming assets have declined 18% over the past year, helping to justify a larger release.
Bank of America released $1.4 billion, comprising 29% of pretax income, and Wells released $900 million, or 11% of pretax income, its biggest release in more than two years. Citigroup released $778 million, down slightly from the second quarter, and the release amounted to 18% of pretax income. At all three, the percentage of pretax income was up from the second quarter, and nonperforming assets have fallen at all four banks at least 18% compared with a year ago.
Bankers say current accounting rules essentially compel them to release reserves when loan losses ease, because the rules use past and current loan losses as the criteria for determining the proper level of reserves. James Dimon, J.P. Morgan’s chairman and chief executive, has been particularly vocal on the issue—at one point in 2012, he said that, while the bank wants to be conservative on its reserves, “the accountants look at a whole bunch of numbers. They make you take it down. So we had to take it down.”
But critics said banks have more discretion than that, and rule makers at the Financial Accounting Standards Board have proposed changes that would require banks to recognize losses based on expectations of further losses. Such a move would lead banks to record loan losses sooner and set aside reserves more quickly, analysts say.
Those potential changes are still pending, and Mr. Curry said in his speech last month that he supports the “thrust” of the FASB proposal.
Write to Michael Rapoport at [email protected]
http://online.wsj.com/news/articles/SB10001424052702304682504579155931092819234

White Paper:  The New FASB Credit Impairment Model
February 2013
Author:  Anne Coughlan
On December 20, 2012, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU), Financial Instruments – Credit Losses (Subtopic 825-15), to obtain feedback on its current expected credit loss (CECL) model for accounting for the impairment of financial assets. The comment period for the proposal ends April 30, 2013; the effective date will be established when the final standard is issued.
Background
Following the financial crisis of 2007 and 2008, there was a perception that existing accounting standards delayed the recognition of credit losses. FASB and the International Accounting Standards Board (IASB) have been working jointly on a new impairment framework and in January 2011 jointly proposed a dual-measure, three-bucket credit impairment model. This model distinguished between financial assets required to use a credit impairment measurement objective of “12 months of expected credit losses” from those that use a credit impairment measurement objective of “lifetime expected credit losses.” Due to strong feedback from U.S. constituents, FASB developed an alternative model, CECL.
Summary
Current U.S. GAAP has several credit impairment models for financial instruments. FASB’s ASU proposes a single expected credit loss measurement objective in determining credit losses for most financial assets.
The ASU eliminates the “probable” recognition threshold on credit losses. Depending on the nature of the financial asset, a credit loss must either be probable or other than temporary before recognition. Under the proposal, an entity would recognize a credit impairment allowance for its current estimate of contractual cash flows not expected to be collected on financial assets held at the reporting date.
The practice of nonaccrual accounting currently originates from guidance issued by regulatory bodies such as the Federal Reserve, Federal Deposit Insurance Corporation or Office of the Comptroller of the Currency. The proposed ASU would add a nonaccrual accounting principle to U.S. GAAP whereby financial assets would be placed on nonaccrual status when it is not probable the entity will receive substantially all of the principal or interest.
The accounting for purchased credit-impaired (PCI) financial assets would change. All loans, whether purchased or originated, would be treated in a similar manner. The CECL model requires an allowance for loan losses to be recorded at acquisition, representing the entity’s assessment of expected credit losses. Current accounting requires an allowance for credit deterioration only subsequent to the purchase date. The portion of the original purchase discount attributed to expected credit losses will not be recognized in interest income as it is under the current standards.
The ASU broadens the information an entity is required to consider in developing its credit loss estimate. Under current GAAP, an entity usually considers past events and current conditions in measuring credit losses. The proposed amendments would require the estimate to be based on relevant information about past events, current conditions and reasonable and supportable forecasts that affect the expected collectability of remaining contractual cash flows.
This impairment would be reflected as an allowance or contra-asset rather than a cost-basis adjustment to the asset.
Financial assets carried at amortized cost less an allowance would reflect the current estimate of the cash flows expected to be collected at the reporting date, and the income statement would reflect credit deterioration (or improvement) that has taken place during the period. For financial assets measured at fair value with changes in fair value recognized through other comprehensive income (FV-OCI), the balance sheet would reflect the fair value, but the income statement would reflect credit deterioration that has taken place during the period.
Under the CECL model, the credit deterioration reflected in the income statement will include changes in the estimate of expected credit losses resulting from any of the following:
1.    Changes in the credit risk of assets held by the entity
2.    Changes in historical loss experience for assets like those held at the reporting date
3.    Changes in conditions since the previous reporting date
4.    Changes in reasonable and supportable forecasts about the future
Scope
All entities, both public and nonpublic, with financial assets not accounted for at fair value through net income (FV-NI) and exposed to potential credit risk would be affected by the proposed amendments. Loans held for investment, available for sale securities, held to maturity securities, trade receivables, lease receivables, loan commitments, reinsurance receivables and any other receivables that represent the contractual right to receive cash are covered by the ASU. Loan held for sale and trading securities are excluded since they are measured at FV-NI.
During the FASB’s outreach activities, many respondents expressed concerns about having to record small impairments on high-quality debt instruments in a gain position, i.e., fair value exceeds carrying amount, because the CECL model requires the calculation of an expected value that incorporates the possibility of loss. FASB has provided a practical expedient for financial assets measured at FV-OCI. Entities would not be required to record an impairment allowance for such assets if the following conditions are met:
•    The fair value of the financial asset equals or exceeds its amortized cost
•    The expected credit losses for the financial asset are insignificant
Implication
The proposed ASU likely would increase the credit loss allowance. Entities will have to modify or significantly enhance their existing financial and risk systems to include a larger asset population and additional inputs, such as forward-looking economic factors, probabilities of default and exposures at default for additional asset classes. The size of additional impairments could affect capital requirements.
Measurement of Expected Credit Loss
At each reporting date, an entity would recognize a credit impairment allowance for its current estimate of contractual cash flows not expected to be collected on financial assets held at the reporting date. The estimation of expected credit losses is highly judgmental. The methods used to estimate expected credit losses may vary based on the type of financial asset and relevant information available to the entity.
Selecting the historical loss data that would be adjusted to reflect current conditions and forecasts involves a variety of judgments and policy elections. Entities will need to give careful consideration to gathering and selecting the most appropriate historical data and market indicators that best reflect their portfolio of financial assets subject to impairment. Externally sourced data would need to be adjusted to reflect a specific entity’s portfolio characteristics.
A number of measurement approaches satisfy the requirements of the CECL model and could be used, and the method used may change over time. For example, a pool of loans initially may use a loss-rate method, but the expected credit losses for certain individual loans may later be measured using a discounted cash flow approach as the credit quality of individual loans in the pool deteriorates. When estimating expected credit losses, the loss rate should be commensurate with the current credit risk of the financial asset. For certain types of lending, credit losses are low shortly after origination, rise rapidly in the early years of a loan and then taper to a lower rate until maturity, so it would be inappropriate to apply an annual loss rate to the remaining years of a loan because loss experience is not linear. For example, a recently funded five-year term loan likely would have a lower probability of default than a 10-year loan with five years left to maturity. Expected credit losses for the loans in the earlier, higher-quality credit grades would typically be much less than expected credit losses for more severely rated loans that have significantly deteriorated in credit quality. This is illustrated in the historical data compiled by Standard & Poor’s below.
Table 1

Cumulative Defaulters by Time Horizon Among Global Corporates, from Original Rating (1981-2010)
Number of issuers     AAA    AA    A    BBB    BB    B    CCC/C    Total
Defaulting within:
One year                3     11     56     45     115
Three years            6     28     123     441     84     682
Five years        2     13     67     258     751     103     1,194
Seven years    2     5     27     98     341     900     111     1,484
Total    7     27     85     181     505     1,090     120     2,015
% of total defaults per time frame
One year    0.0    0.0    0.0    2.6    9.6    48.7    39.1
Three years    0.0    0.0    0.9    4.1    18.0    64.7    12.3
Five years    0.0    0.2    1.1    5.6    21.6    62.9    8.6
Seven years    0.1    0.3    1.8    6.6    23.0    60.6    7.5
Total    0.3    1.3    4.2    9.0    25.1    54.1    6.0
Sources:  Standard & Poor’s Global Fixed Income Research and Standard & Poor’s CreditPro®.
An entity has latitude to develop estimation techniques that are applied consistently over time. The ASU describes the key principles that must be followed, described in detail below.
Range of Information
The estimate of expected credit losses should be based on relevant information about past events, including historical loss experience with similar assets, current conditions and reasonable and supportable forecasts that affect the expected collectability of the assets’ remaining contractual cash flows. An entity only need consider information that is reasonably available without undue cost and effort, and it can use both internal and external information—including qualitative and quantitative factors—to estimate expected credit losses. An entity should assess general economic conditions and the forecasted direction of the economic cycle, and the estimated loss should be adjusted as needed for any current information that may indicate current expectations about loss that is not reflected in the historical experience.
Time Value of Money
The time value of money must be reflected in the estimate of expected credit losses either explicitly or implicitly. A discounted cash flow (DCF) model is an example of a method that explicitly reflects the time value of money by forecasting future cash flows and discounting these amounts to a present value using the effective interest rate. The proposal does not require an entity to perform a DCF analysis for individual securities at the end of each reporting period. Other methods implicitly reflect the time value of money include a loss-rate method, roll-rate method and probability-of-default method. Using the fair value of collateral (less estimated costs to sell) for collateral-dependent loans implicitly satisfies this requirement.
Loss Probabilities
The estimate of expected credit losses must incorporate a range of at least two possible outcomes—both the possibility that a credit loss results and that no credit loss results. An entity is prohibited from estimating expected credit losses based solely on the most likely outcome. The proposal does not require multiple probability weighted credit loss scenarios, such as a Monte Carlo simulation. A variety of methods might be used, including a loss-rate method, roll-rate method, probability-of-default method and provision matrix method using loss factors. These models inherently satisfy the requirement because the loan population that serves as the denominator for the loss ratios in these models is extensive and includes both loss and no-loss outcomes. Using the fair value of collateral (for collateral dependent assets) satisfies this requirement because the fair value of collateral reflects several potential outcomes on a market-weighted basis and may result in expected credit losses of zero when the fair value of collateral exceeds the amortized cost basis of the asset.
Unit of Account
The CECL model does not prescribe a unit of account (individual account or group of assets) to be used. Entities can leverage existing internal credit risk management systems to implement the CECL model. In determining the appropriate level of internal reporting, entities should consider the level of detail needed by a user to understand the risks inherent in the entity’s financial assets. An entity should segment its financial assets first by portfolio segment and then by measurement attribute (amortized cost or FV-OCI). Classes should then be disaggregated to the level an entity uses when assessing and monitoring the risk and performance of the portfolio. This assessment shall consider the risk characteristics of the financial asset. Common groupings include categorization of borrowers (commercial or consumer), type of financial asset (mortgage loans, credit card loans, corporate debt securities, trade receivable or lease receivable) or type of collateral (residential, commercial, government-guaranteed or uncollateralized). An entity may estimate expected credit losses for some financial assets on a collective basis and estimate expected credit losses for other assets on an individual basis.
Risk Mitigators
The estimate of expected credit losses would reflect credit enhancements that mitigate expected credit losses, such as guarantors, downgrade collateral provisions and impact of subordinated interests that absorb a portion of credit losses.  Separate free-standing contracts, such as purchased credit-default swaps, should NOT be factored into the expected credit loss estimate.
Write-Offs
The proposal carries forward the existing requirements for write-offs. When there is no reasonable expectation of future recovery, an entity shall reduce the cost basis of a financial asset. The allowance would be reduced by the amount written off. Any subsequent recoveries would be recognized as adjustment to the allowance only when consideration is received. Current GAAP does not permit reversal of impairments on debt securities.
Loan Modifications
The CECL model would apply to all modified financial assets such as troubled debt restructuring (TDR). The proposed ASU does not change the existing accounting for derecognition or what constitutes a TDR. Expected credit losses would be recognized on the expected shortfall in the post-modification contractual cash flows discounted using the new post-modification effective interest rate. The cost basis of the TDR would be adjusted so the effective interest rate post-modification is the same as the original effective interest rate, given the new series of contractual cash flows. The basis adjustment would be calculated as the amortized cost basis before modification less the present value of the modified contractual cash flows (discounted at the original effective interest rate). Under current U.S. GAAP, impairment from the restructuring is recorded as an allowance, not a write-off as described above.
Loan Commitments
An entity would recognize all expected credit losses on loan commitments not classified at FV-NI. An entity would estimate credit losses over the full contractual period of the loan commitment unless unconditionally cancellable by the issuer. The estimate of expected credit losses should incorporate probabilities of funding and drawdowns, factoring in risk mitigants such as a material adverse change clause.
Purchased Credit-Impaired (PCI) Financial Assets
PCI assets are acquired individual assets, or acquired groups of financial assets with shared risk characteristics, that have experienced a significant deterioration in credit quality since origination, based on the assessment of the buyer. PCI assets would follow the same approach as originated assets for purposes of credit impairment. Upon acquisition and at each reporting date, an entity would recognize a credit impairment allowance for its current estimate of the contractual cash flows the entity does not expect to collect. The portion of the original purchase discount attributed to expected credit losses will not be recognized in interest income, as is the current practice. The remaining portion of the discount not attributed to expected credit losses would be recognized in interest income over the remaining life of the asset using an effective yield method. The effective yield determined at acquisition will be held constant and any changes in expected cash flows, i.e., changes in the allowance for loan losses, will be recorded as gains and losses through the credit loss provision. Balance sheet and income statement amounts for originated and purchased credit impaired financial assets would still be presented separately.
Nonaccrual Accounting
The proposed ASU requires financial assets to be placed on nonaccrual status when it is not probable an entity will receive substantially all of the principal or interest.
If it is not probable an entity would receive substantially all the principal from an asset, an entity would apply the cost recovery method, whereby all cash receipts are a reduction in the carrying amount of the asset. When the carrying amount has been reduced to zero, additional payments would be recognized as recoveries of amounts previously written off, with any excess recognized as interest income.
If it is not probable an entity would receive substantially all of the interest, it would apply the cash basis method, and any cash received would be recognized as interest income. This most often occurs when the value of collateral exceeds the amortized cost basis of a financial asset. Cash receipts exceeding contractual interest would reduce the carrying amount of the asset.
Disclosure
The disclosures required in the proposed ASU are intended to give financial statement readers an understanding of the portfolio’s credit risk, how management monitors the portfolio’s credit quality, management’s estimate of expected credit losses and changes in the estimate that have taken place during the period. The disclosure carries forward some of the requirements of ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, such as those related to quantitative and qualitative information about credit quality, including the amount of recorded investment by credit quality indicator. The following items would be required:
•    Credit-quality information – Quantitative and qualitative information by class of financial asset, including a description of the credit quality indicator, amortized cost by indicator and last date the indicator was updated; if an entity discloses internal risk ratings, it shall provide qualitative information on how those internal risk ratings relate to the likelihood of loss.
•    Allowance for expected credit losses – For each portfolio segment, a description of the accounting policies and methodology used to estimate the allowance for expected credit losses would be disclosed, including inputs, assumptions and a description of any forecasts affecting the estimate. Any policy or methodology changes from the prior period would be noted, as well as the reasons for significant write-offs. A quantitative roll-forward of the allowance is mandated including the beginning balance, current provisions, write-offs, recoveries and ending balance. Separate tables are required for financial assets measured at amortized cost and FV-OCI.
•    Roll-forward for certain debt instruments – For debt instruments classified at amortized cost and FV-OCI, the roll-forward should include beginning amortized cost, originations, purchases, sales, repayments, write-offs and ending amortized cost.
•    Reconciliation between fair value and amortized cost – For debt instruments classified at FV-OCI, if not presented on the balance sheet
•    Past-due status – For each portfolio segment, an entity would provide an aging analysis of the amortized cost for debt instruments that are past due as of the reporting date, as well as a description of when an entity considers a debt instrument to be past due.
•    Nonaccrual status – For each portfolio segment, an entity would disclose all of the following:
o    The amortized cost of debt instruments on nonaccrual status as of the beginning of the reporting period and end of the reporting period
o    The amount of interest income recognized during the period on nonaccrual debt instruments
o    The amortized cost of debt instruments that are 90 days or more past due, but not on nonaccrual status as of the reporting date
o    The amortized cost of debt instruments on nonaccrual status for which there are no related expected credit losses as of the reporting date because the debt instrument is a fully collateralized collateral-dependent financial asset
•    PCI financial assets – For any PCI assets purchased in the current period, the purchase price, credit loss discount, noncredit discount and par value should be disclosed.
•    Collateralized financial assets – For each financial asset class, a description is required for the type of collateral provided and the extent to which the collateral secures an entity’s financial assets. Any significant changes in the level of collateralization from the prior period would be disclosed.
Transition Guidance for the CECL Model
The transition method for the CECL model would be a cumulative-effect approach. An entity would record a cumulative-effect adjustment to its statement of financial position as of the beginning of the first reporting period in which the guidance is effective.
For more information on how the proposed guidance affects you, contact your BKD advisor.
http://www.bkd.com/articles/2013/white-paper-the-new-fasb-credit-impairment-model.htm
To find additional articles, go to:
http://www.library.fullerton.edu/
In Basic Article Search, search for companies.
Google Scholar might yield academic articles:
http://scholar.google.com/
You may find articles by financial analysts, traders, and investors at:
http://seekingalpha.com/
http://finviz.com/
Format
Your research paper must use the following format:
1.    Financial Instruments—Credit Losses (Subtopic 825-15)
Explain, in your own words, the proposed changes in accounting standards for credit losses.
2.    Comment Letters
Summarize, in your own words, the most important points made in comment letters.
http://www.fasb.org/jsp/FASB/CommentLetter_C/CommentLetterPage&cid=1218220137090&project_id=2012-260

3.    Wharton Research Data Services (WRDS)
Explain, for several major banks, the extent of detailed disclosures found in WRDS for loan loss reserves.
4.    Form 10-K and other Public Disclosures
Explain any additional details available from Form 10-K or other disclosures made by major banks.
You will find public disclosures at the SEC’s EDGAR web site and at other web sites:
http://www.sec.gov/edgar/quickedgar.htm
http://www.secinfo.com/
5.    SAP ERP
Note:  This is a major subheading.  While it is only one subheading, you need to provide extensive coverage of this topic.
Explain which SAP ERP transaction codes that you would use and the level of details maintained by the system for the accounting policies covered in parts one through four.  You must include in the appendices of screen shots of the transactions you generated.
The best place to start your research for documentation on SAP ERP is the SAP Help Portal:
http://help.sap.com/
If you perform an Internet search for SAP transaction codes, you will discover web sites specializing in this subject, such as:
http://www.saptransactioncodes.com/
Please note that CSUF does not have the special version of SAP ERP for banks.  You may find also references to add on resources, such as SEM.  You must explain these resources, too.
The following is the first page of help pages found using the search terms:  bank loan loss reserves

Bank Profitability Analysis (SAP Library – SEM Banking (US))
Help Documentation | (HTML 23 KB) | SAP SCM SAP SNC, UI add-on 1.0
Bank Profitability Analysis Technical Name: 0SEMPA_C2 Use The InfoCube… InfoObject Description 0BA_ACLOFEE Accruing Loan Fees 0BA_ACTPROV Actual Loan Fees 0BA_DEPRESE Deposit Reserve…
Show this topic in other releases»
Reserve for Bad Debts (RBD) (SAP Library – FS Reserve for Bad Debts (RBD))
Help Documentation | (HTML 101 KB) | SAP ERP 6.0
Reserve for Bad Debts (RBD) Purpose The Reserve for Bad Debts (RBD… management and accounting policy at your bank, you need to…Risk Class” field in the loan…
Show this topic in other releases»
Bank Profitability Analysis (SAP Library – SEM Banking (US))
Help Documentation | (HTML 23 KB) | SAP Solution Manager 7.0 SP15
… Bank Profitability Analysis Technical Name: 0SEMPA_C2 Use The InfoCube… InfoObject Description 0BA_ACLOFEE Accruing Loan Fees 0BA_ACTPROV Actual Loan Fees 0BA_DEPRESE Deposit Reserve…
Show this topic in other releases»
Reserve for Bad Debts (RBD) (SAP Library – Reserve for Bad Debts (RBD))
Help Documentation | (HTML 101 KB) | SAP ERP 6.0
… Reserve for Bad Debts (RBD) Purpose The Reserve for Bad Debts (RBD… management and accounting policy at your bank, you need to…Risk Class” field in the loan…

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6.    Conclusions
What are the advantages and disadvantages of the proposed changes in accounting standards?
7.    References
Include complete references using a major citation style (such as Chicago).  Do NOT use or reference elementary sources, such as Wikipedia, encyclopedias, newspapers, or magazines.  Use only the highest quality evidence, such as peer-reviewed academic articles available at CSUF’s Library.
Many Web sites compare citation styles, such as:
http://www.liu.edu/cwis/cwp/library/workshop/citation.htm
8.    Appendices
Number and label your appendices.  On each page, show the source (even if you are the source because you created your own Excel charts).
Some possible ways to find disclosures are:
http://www.sec.gov/edgar.shtml
http://www.secinfo.com/
http://www.finviz.com
http://finance.yahoo.com/
http://www.google.com/finance

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