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March/April 2018 Issue: Front Page > Feature

Credit Loss Estimates and Available-For-Sale Securities
a page of Spreadsheet tables and charts with a calculator and magnifying glass on top While the preparation emphasis for the Current Expected Credit Loss (CECL) standard in natural person credit unions is justly focused on loan portfolios, we'd like to briefly turn your attention to assessing credit losses for available-for-sale (AFS) debt securities. Ultimately the Financial Accounting Standards Board determined that CECL will not apply to AFS securities, and instead regrouped and modified the related guidance under subtopic ASC 326-30. Credit unions that invest in AFS debt securities typically seek high credit quality issues, however it's worthwhile to consider a few points as you prepare for this upcoming standard. Please note that this article is by no means comprehensive and is meant to give you the ability to begin preparation. You should seek guidance from certified public accountants and regulators to ensure compliance.

To comply with ASC 326-30, if an AFS security's fair value falls below your amortized cost basis, you'll be expected to assess if any or all of the decline in value is due to credit-related factors. It is important to note that AFS security impairments are assessed at the individual security level, unlike CECL where pooling may be appropriate. Credit losses should be recorded through an allowance for credit loss; a direct write down of the asset's cost basis is only appropriate if a credit union intends to sell or more likely than not will be required to sell the security prior to recovery of the security’s amortized cost basis. The extent of a potential credit loss is limited by the amount that fair value is less than amortized cost basis. Once a credit loss has been recorded for a security, that loss could increase if conditions worsen, could decrease based on improvement, or could even reverse back to zero. Any impairment that is not recorded through an allowance for credit loss should be recorded through other comprehensive income, as you're accustomed to treating unrealized gains and losses.

Even if you're comfortable understanding the accounting treatment discussed above, you may wonder how to differentiate between credit-related events and other influences on fair value like general changes in the interest rate environment. The ultimate determination of a possible credit loss is reached by comparing the security’s amortized cost basis, or book value, to the present value of future cash flows expected to be collected. While CECL allows several modeling methods for other types of assets, only the discounted cash flow model is acceptable for AFS securities under the new standard. For fixed rate securities, these cash flows should be discounted at the effective interest rate, or the contractual interest rate at your time of acquisition, adjusted for premiums and discounts. For floating rate securities based on an index like LIBOR, the rate may be updated as it changes over the life of the security or fixed at the time a credit loss is initially assessed, but the choice should be applied consistently to all floating rate AFS securities held. The key is for your future cash flow estimates to be based on past events, current conditions, and on reasonable and supportable forecasts.

There are many factors that can play a role in your credit assessment, but some are specifically worthy of consideration. Although length of time in an unrealized loss position cannot factor into the model, the extent of your unrealized loss can. If the security's issuer or collateral is specifically concentrated in particular industries or regions, adverse changes in these factors should play a role in your credit analysis. The last decade has made it very clear that investors cannot rely solely on ratings agencies, but credit ratings can be incorporated to the extent that they influence expected cash flows estimates. Intuitively, defaults in interest and principal payments should be considered. When incorporating forward-looking economic forecasts, think back to the phrase reasonable and supportable; your forecasts should be supported by objective evidence.

AFS Debt Securities Impairment Assessment
Flowchart for determining Available-For-Sale Securities Impairment Assessment
Click above image to view in PDF format.

Up to this point, we haven't even broached the subject of disclosures. This new accounting standard requires disclosures that enable financial statement users to understand the credit risk inherent to AFS securities, management’s assessment of credit losses, and changes in credit losses that occurred during the presented reporting period. A detailed discussion of disclosures related to AFS securities is beyond the scope of this article, but in addition to compliance with the standard, an overall objective should be to provide sufficient details while avoiding excessive details that impair financial statement usability.

For credit unions, FASB’s new accounting guidance on credit losses will be effective for fiscal years beginning after December 15, 2020. As we’ve reiterated in prior VolVoice editions, it is important for credit unions to begin preparation now. You can look forward to more CECL-related content and trainings from VolCorp in the future!

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