[Federal Register Volume 84, Number 227 (Monday, November 25, 2019)]
[Rules and Regulations]
[Pages 64733-64738]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-25450]


=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 211

[Release No. SAB 119]


Staff Accounting Bulletin No. 119

AGENCY: Securities and Exchange Commission.

ACTION: Publication of Staff Accounting Bulletin.

-----------------------------------------------------------------------

SUMMARY: This staff accounting bulletin updates portions of the 
interpretive guidance included in the Staff Accounting Bulletin Series 
in order to align the staff's guidance with Financial Accounting 
Standards Board (``FASB'') Accounting Standards Codification (``ASC'') 
Topic 326, Financial Instruments--Credit Losses (``Topic 326'').

DATES: Effective: November 25, 2019.

FOR FURTHER INFORMATION CONTACT: Rachel Mincin, Associate Chief 
Accountant, Office of the Chief Accountant at (202) 551-5300, or 
Stephanie Sullivan, Associate Chief Accountant, Division of Corporation 
Finance at (202) 551-3400, Securities and Exchange Commission, 100 F 
Street NE, Washington, DC 20549.

SUPPLEMENTARY INFORMATION: In 2016, the FASB adopted ASC Topic 326 
through its issuance of Accounting Standards Update No. 2016-13, 
Financial Instruments--Credit Losses (Topic 326): Measurement of Credit 
Losses on Financial Instruments.\1\ Upon its effective date, this 
standard will replace the existing incurred loss model for determining 
the allowance for loan losses with an expected credit loss model. The 
staff is publishing this staff accounting bulletin to update existing 
staff guidance \2\ with respect to methodologies and supporting 
documentation for measuring credit losses. This updated guidance 
continues to focus on the documentation the staff would normally expect 
registrants engaged in lending transactions to prepare and maintain to 
support estimates of current expected credit losses for loan 
transactions. This update is applicable upon a registrant's adoption of 
Topic 326.
---------------------------------------------------------------------------

    \1\ ASC Topic 326 was subsequently amended through the issuances 
of Accounting Standards Update (``ASU'') No. 2018-19, Codification 
Improvements to Topic 326, Financial Instruments--Credit Losses, ASU 
No. 2019-04, Codification Improvements to Topic 326, Financial 
Instruments--Credit Losses, Topic 815, Derivatives and Hedging, and 
Topic 825, Financial Instruments, ASU No. 2019-05, Financial 
Instruments--Credit Losses, Topic 326: Targeted Transition Relief, 
and ASU No. 2019-10, Financial Instruments--Credit Losses (Topic 
326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): 
Effective Dates.
    \2\ See Codification of SABs Topic 6, Section L: Financial 
Reporting Release No. 28--Accounting for Loan Losses by Registrants 
Engaged in Lending Activities, which codified SAB No. 102--Selected 
Loan Loss Allowance Methodology and Documentation Issues, 66 FR 
36457 (July 12, 2001).
---------------------------------------------------------------------------

    On November 15, 2019, the FASB delayed the effective date of the 
standard for certain small public companies and other private 
companies.\3\ As amended, the effective date of ASC Topic 326 was 
delayed until fiscal years beginning after December 15, 2022 for SEC 
filers that are eligible to be smaller reporting companies under the 
SEC's definition, as well as private companies and not-for-profit 
entities. Nothing in this staff accounting bulletin should be read to 
accelerate or delay the effective dates of the standard as modified by 
the FASB.
---------------------------------------------------------------------------

    \3\ See ASU No. 2019-10, Financial Instruments--Credit Losses 
(Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 
842): Effective Dates
---------------------------------------------------------------------------

    The statements in SABs are not rules or interpretations of the 
Commission, nor are they published as bearing the Commission's official 
approval. They represent staff interpretations and practices followed 
by the staff in the Division of Corporation Finance and the Office of 
the Chief Accountant in administering the disclosure requirements of 
the federal securities laws.

List of Subjects in 17 CFR Part 211

    Accounting, Reporting and recordkeeping requirements, Securities.


[[Page 64734]]


    Dated: November 19, 2019.
Vanessa A. Countryman,
Secretary.

    Accordingly, part 211 of title 17 of the Code of Federal 
Regulations is amended as follows:

PART 211--INTERPRETATIONS RELATING TO FINANCIAL REPORTING MATTERS

0
1. The authority citation for 17 CFR part 211 continues as follows:

    Authority: 15 U.S.C. 77g, 15 U.S.C. 77s(a), 15 U.S.C. 77aa(25) 
and (26), 15 U.S.C. 78c(b), 17 CFR 78l(b) and 13(b), 17 CFR 78m(b) 
and 15 U.S.C. 80a-8, 30(e) 15 U.S.C. 80a-29(e), 15 U.S.C. 80a-30, 
and 15 U.S.C. 80a-37(a).


0
2. Amend the table in subpart B by adding an entry for Staff Accounting 
Bulletin No. 119 at the end of the table to read as follows:

Subpart B--Staff Accounting Bulletins

----------------------------------------------------------------------------------------------------------------
            Subject                  Release No.           Date                    FR vol. and page
----------------------------------------------------------------------------------------------------------------
 
                                                  * * * * * * *
Publication of Staff            SAB119..............      11/25/2019  [INSERT FEDERAL REGISTER CITATION].
 Accounting Bulletin No. 119.
----------------------------------------------------------------------------------------------------------------


    Note: The text of Staff Accounting Bulletin No. 119 will not 
appear in the Code of Federal Regulations.

Staff Accounting Bulletin No. 119

    The staff hereby adds Section M to Topic 6 of the Staff Accounting 
Bulletin Series. Accordingly, the staff hereby amends the Staff 
Accounting Bulletin Series as follows:
* * * * *

Topic 6: Interpretations of Accounting Series Releases and Financial 
Reporting Releases

* * * * *

M. Financial Reporting Release No. 28--Accounting for Loan Losses by 
Registrants Engaged in Lending Activities Subject to FASB ASC Topic 326

1. Measuring Current Expected Credit Losses
    General: This staff interpretation applies to all registrants that 
are creditors in loan transactions that, individually or in the 
aggregate, have a material effect on the registrant's financial 
condition.\4\
---------------------------------------------------------------------------

    \4\ This staff interpretation relates to Financial Reporting 
Release No. 28--Accounting for Loan Losses by Registrants Engaged in 
Lending Activities, Release No. 33-6679 (Dec. 1, 1986), (hereinafter 
``FRR 28'').
---------------------------------------------------------------------------

    FASB ASC Subtopic 326-20 addresses the measurement of current 
expected credit losses for financial assets measured at amortized cost 
basis, net investments in leases recognized by lessors, reinsurance 
recoverables, and certain off-balance-sheet credit exposures.\5\
---------------------------------------------------------------------------

    \5\ See ASC paragraphs 326-20-15-2 and 326-20-15-3.
---------------------------------------------------------------------------

    At each reporting date, an entity shall record an allowance for 
credit losses on financial assets measured at amortized cost basis and 
net investments in leases recognized by lessors and shall record a 
liability for credit losses on certain off-balance-sheet exposures not 
accounted for as insurance or derivatives, including loan commitments, 
standby letters of credit, and financial guarantees.\6\
---------------------------------------------------------------------------

    \6\ Ibid.
---------------------------------------------------------------------------

    For financial asset(s), the allowance for credit losses is a 
valuation account that is deducted from, or added to, the amortized 
cost basis of the financial asset(s) to present the net amount expected 
to be collected on the financial asset(s).\7\
---------------------------------------------------------------------------

    \7\ See ASC paragraph 326-20-30-1.
---------------------------------------------------------------------------

    The allowance for credit losses is an estimate of current expected 
credit losses considering available information relevant to assessing 
collectibility of cash flows over the contractual term of the financial 
asset(s).\8\
---------------------------------------------------------------------------

    \8\ As indicated in ASC paragraph 326-20-30-11, the liability 
for expected credit losses for off-balance-sheet credit exposures 
shall be based on the contractual period in which the entity is 
exposed to credit risk via a present obligation to extend credit, 
unless the obligation is unconditionally cancellable by the issuer.
---------------------------------------------------------------------------

    Information relevant to establishing an estimate of current 
expected credit losses includes historical credit loss experience on 
financial assets with similar risk characteristics, current conditions, 
and reasonable and supportable forecasts that affect the collectability 
of the remaining cash flows over the contractual term of the financial 
assets. An entity shall report in net income (as a credit loss expense) 
the amount necessary to adjust the allowance for credit losses and 
liabilities for credit losses on off-balance-sheet credit exposures for 
management's current estimate of expected credit losses.\9\
---------------------------------------------------------------------------

    \9\ See ASC paragraphs 326-20-30-1, 326-20-30-6, 326-20-30-7 and 
326-20-30-11.
---------------------------------------------------------------------------

    This staff guidance is applicable upon a registrant's adoption of 
FASB ASC Topic 326.\10\ Upon a registrant's adoption of FASB ASC Topic 
326, the staff guidance in SAB Topic 6, Section L: Financial Reporting 
Release No. 28--Accounting for Loan Losses by Registrants Engaged in 
Lending Activities \11\ will no longer be applicable.
---------------------------------------------------------------------------

    \10\ See ASC paragraphs 326-10-65-1, 326-10-65-2, and 326-10-65-
3.
    \11\ Originally added to the Codification of SABs in Topic 6, 
Section L, by SAB No. 102--Selected Loan Loss Allowance Methodology 
and Documentation Issues, 66 FR 36457 (July 12, 2001).
---------------------------------------------------------------------------

    On November 15, 2019, the FASB delayed the effective date of FASB 
ASC Topic 326 for certain small public companies and other private 
companies. As amended, the effective date of ASC Topic 326 was delayed 
until fiscal years beginning after December 15, 2022 for SEC filers 
that are eligible to be smaller reporting companies under the SEC's 
definition, as well as private companies and not-for-profit entities. 
Nothing in this staff interpretation should be read to accelerate or 
delay the effective dates of the standard as modified by the FASB.
2. Development, Governance, and Documentation of a Systematic 
Methodology
    Facts: Registrant A is developing (or subsequently reviewing) its 
allowance for credit losses methodology for its loan portfolio.
    Question 1: What are some of the factors or elements that the staff 
normally would expect Registrant A to consider when developing (or 
subsequently performing an assessment of) its methodology for 
determining its allowance for credit losses under GAAP?
    Interpretive Response: The staff normally would expect a registrant 
to have a systematic methodology to address the development, 
governance, and documentation to determine its provision and allowance 
for credit losses.
    It is critical that allowance for credit losses methodologies 
incorporate management's current judgments about

[[Page 64735]]

the credit losses expected from the existing loan portfolio, including 
reasonable and supportable forecasts about changes in credit quality of 
these portfolios, on a disciplined and consistently-applied basis.
    A registrant's allowance for credit losses methodology is 
influenced by entity-specific factors, such as an entity's size, 
organizational structure, access to information, business environment 
and strategy, management's risk assessment, complexity of the loan 
portfolio, loan administration procedures, and management information 
systems. Management is responsible for the estimate of expected credit 
losses, and therefore also responsible for determining whether any 
allowance methodologies developed by third parties are consistent with 
GAAP.
    While different registrants may use different methods,\12\ there 
are certain common elements that the staff would expect in any 
methodology:
---------------------------------------------------------------------------

    \12\ ASC paragraph 326-20-30-3 states that ``[t]he allowance for 
credit losses may be determined using various methods. For example, 
an entity may use discounted cash flow methods, loss-rate methods, 
roll-rate methods, probability-of-default methods, or methods that 
utilize an aging schedule.''
---------------------------------------------------------------------------

     Identify relevant risk characteristics and pool loans on 
the basis of similar risk characteristics; \13\
---------------------------------------------------------------------------

    \13\ See ASC paragraph 326-20-55-5 for a list of risk 
characteristics that may be applicable.
---------------------------------------------------------------------------

     Consider available information relevant to assessing the 
collectibility of cash flows; \14\
---------------------------------------------------------------------------

    \14\ See ASC paragraph 326-20-30-7.
---------------------------------------------------------------------------

     Consider expected credit losses over the contractual term 
\15\ of all existing loans (whether on an individual or group basis), 
and measure expected credit losses on loans on a collective (pool) 
basis when similar risk characteristics exist; \16\
---------------------------------------------------------------------------

    \15\ See ASC paragraph 326-20-30-6.
    \16\ See ASC paragraph 326-20-30-2
---------------------------------------------------------------------------

     Require that analyses, estimates, reviews, and other 
allowance for credit losses methodology functions be performed by 
competent and well-trained personnel;
     Be based on reliable and relevant data and an analysis of 
current conditions and reasonable and supportable forecasts;
     Include a systematic and logical method to consolidate the 
loss estimates that allows for the allowance for credit losses balance 
to be recorded in accordance with GAAP.
    The staff believes an entity's management should review, on a 
periodic basis, whether its methodology for determining its allowance 
for credit losses is appropriate. Additionally, for registrants that 
have audit committees, the staff believes that oversight of the 
financial reporting and auditing of the allowance for credit losses by 
the audit committee can strengthen the registrant's process for 
determining its allowance for credit losses.
    A systematic methodology that is properly designed and implemented 
should result in a registrant's best estimate of its allowance for 
credit losses.\17\ Accordingly, the staff normally would expect 
registrants to adjust their allowance for credit losses balance, either 
upward or downward, in each period for differences between the results 
of the systematic methodology and the unadjusted allowance for credit 
losses balance in the general ledger.\18\
---------------------------------------------------------------------------

    \17\ ASU 2016-13, BC63 states that ``the Board decided that an 
entity should determine at the reporting date an estimate of credit 
loss that best reflects its expectations (or its best estimate of 
expected credit loss).''
    \18\ See ASC paragraph 326-20-35-1 and 326-20-35-3. Registrants 
should also refer to the guidance on materiality in SAB Topic 1.M.
---------------------------------------------------------------------------

    Question 2: In the staff's view, what aspects of a registrant's 
allowance for credit losses internal accounting controls would need to 
be appropriately addressed in its written policies and procedures?
    Interpretive Response: Registrants may utilize a wide range of 
policies, procedures, and control systems in their allowance for credit 
losses processes, and these policies, procedures, and systems are 
tailored to the size and complexity of the registrant and its loan 
portfolio.
    However, the staff believes that, in order for a registrant's 
allowance for credit losses methodology to be effective, the 
registrant's written policies and procedures for the systems and 
controls that maintain an appropriate allowance for credit losses would 
likely address the following:
     The roles and responsibilities of the registrant's 
departments and personnel (including the lending function, credit 
review, financial reporting, internal audit, senior management, audit 
committee, board of directors, and others, as applicable) who determine 
or review, as applicable, the allowance for credit losses to be 
reported in the financial statements;
     The registrant's selected methods and policies for 
developing the allowance for credit losses and determining significant 
judgments;
     The description of the registrant's systematic 
methodology, which should be consistent with the registrant's 
accounting policies for determining its allowance for credit losses 
(see Question 4 below for further discussion); and
     How the system of internal controls related to the 
allowance for credit losses process provides reasonable assurance that 
the allowance for credit losses is in accordance with GAAP.
    The staff normally would expect internal accounting controls \19\ 
for the allowance for credit losses estimation process to:
---------------------------------------------------------------------------

    \19\ Public companies are required to comply with the books and 
records and internal controls provisions of the Exchange Act. See 
Sections 13(b)(2)-(7) of the Exchange Act.
---------------------------------------------------------------------------

     Include measures to provide reasonable assurance regarding 
the reliability and integrity of information and compliance with laws, 
regulations, and internal policies and procedures; \20\ and
---------------------------------------------------------------------------

    \20\ Section 13(b)(2)-(7) of the Exchange Act.
---------------------------------------------------------------------------

     Operate at a level of precision sufficient to provide 
reasonable assurance that the registrant's financial statements are 
prepared in accordance with GAAP.
    Question 3: Assume the same facts as in Question 1. What would the 
staff normally expect Registrant A to include in its documentation of 
its allowance for credit losses methodology?
    Interpretive Response: In FRR 28, the Commission provided guidance 
for documentation of loan loss provisions and allowances for 
registrants engaged in lending activities. The staff believes that 
appropriate written supporting documentation for the provision and 
allowance for credit losses facilitates review of the allowance for 
credit losses process and reported amounts, builds discipline and 
consistency into the allowance for credit losses methodology, and helps 
to evaluate whether relevant factors are appropriately considered in 
the allowance analysis.
    The staff, therefore, normally would expect a registrant to 
document the relationship between its detailed analysis of the 
characteristics and credit quality of the portfolio and the amount of 
the allowance for credit losses reported in each period.\21\
---------------------------------------------------------------------------

    \21\ FRR 28, Section II states that ``[t]he specific rationale 
upon which the [loan loss allowance and provision] amount actually 
reported in each individual period is based--i.e., the bridge 
between the findings of the detailed review [of the loan portfolio] 
and the amount actually reported in each period--would be documented 
to help ensure the adequacy of the reported amount, to improve 
auditability, and to serve as a benchmark for exercise of prudent 
judgment in future periods.''
---------------------------------------------------------------------------

    The staff normally would expect registrants to maintain written 
supporting documentation for the following decisions and processes:
     Policies and procedures over the systems and controls that 
maintain an appropriate allowance for credit losses;

[[Page 64736]]

     Allowance for credit losses methodology and key judgments, 
including the data used, assessment of risk, and identification of 
significant assumptions in the allowance estimation process;
     Summary or consolidation of the allowance for credit 
losses balance;
     Validation of the allowance for credit losses methodology; 
and
     Periodic adjustments to the allowance for credit losses.
    Question 4: What elements of a registrant's allowance for credit 
losses methodology would the staff normally expect to be described in 
the registrant's written policies and procedures?
    Interpretive Response: The staff normally would expect a 
registrant's written policies and procedures to describe the primary 
elements of its allowance for credit losses methodology. The staff 
normally would expect that, in order for a registrant's allowance for 
credit losses methodology to be effective, the registrant's written 
policies and procedures would describe all primary elements needed to 
support a disciplined and consistently-applied methodology, which may 
include, but is not limited to: \22\
---------------------------------------------------------------------------

    \22\ See also, ASC paragraph 326-20-55-6 for additional 
judgments a registrant may make.
---------------------------------------------------------------------------

     How portfolio segments are determined (e.g., by loan type, 
industry, risk rating, etc.) \23\ and the methodology used for each 
portfolio segment; \24\
---------------------------------------------------------------------------

    \23\ FASB ASC Subtopic 326-20-20 defines a portfolio segment as 
the ``level at which an entity develops and documents a systematic 
methodology to determine its allowance for credit losses.''
    \24\ See ASC paragraph 326-20-30-3 for examples of expected loss 
estimation methods that may be used.
---------------------------------------------------------------------------

     The approach used to pool loans based on similar risk 
characteristics;
     For accounting policy or practical expedient elections set 
forth in FASB ASC Subtopic 326-20, documentation of the elections made;
     The method(s) used to determine the contractual term of 
the financial assets, including consideration of prepayments and when 
the contractual term is extended; \25\
---------------------------------------------------------------------------

    \25\ See ASC paragraph 326-20-30-6.
---------------------------------------------------------------------------

     If a loss-rate method is used, the historical data used to 
develop the components of the loss rate and how that rate is applied to 
the amortized cost basis of the financial asset as of the reporting 
date; \26\
---------------------------------------------------------------------------

    \26\ See ASC paragraph 326-20-30-5.
---------------------------------------------------------------------------

     The method for estimating expected recoveries when 
measuring the allowance for credit losses; \27\
---------------------------------------------------------------------------

    \27\ See ASC paragraph 326-20-30-1.
---------------------------------------------------------------------------

     The approach used to determine the appropriate historical 
period for estimating expected credit loss statistics;
     The approach used to determine the reasonable and 
supportable period;
     The approach used to adjust historical information for 
current conditions and reasonable and supportable forecasts; \28\
---------------------------------------------------------------------------

    \28\ See ASC paragraph 326-20-30-8 and 326-20-30-9.
---------------------------------------------------------------------------

     How the entity plans to revert to historical credit loss 
information for periods beyond which the entity is able to make or 
obtain reasonable and supportable forecasts of expected credit losses; 
\29\ and
---------------------------------------------------------------------------

    \29\ See ASC paragraph 326-20-30-9
---------------------------------------------------------------------------

     The approach used to determine when a purchased financial 
asset would qualify to be accounted for as a purchased financial asset 
with credit deterioration.\30\
---------------------------------------------------------------------------

    \30\ See ASC paragraph 326-20-30-13 through 326-20-30-15.
---------------------------------------------------------------------------

3. Documenting the Results of a Systematic Methodology
    Question 5: What documentation would the staff normally expect a 
registrant to prepare to support its allowance for credit losses for 
its loans under FASB ASC Subtopic 326-20?
    Interpretive Response: Regardless of the method used to determine 
the allowance for credit losses under FASB ASC Subtopic 326-20, the 
staff normally would expect a registrant to demonstrate in its 
documentation that the loss measurement methods and assumptions used to 
estimate the allowance for credit losses for its loan portfolio are 
determined in accordance with GAAP as of the financial statement date.
    The staff normally would expect a registrant to maintain as 
sufficient evidence written documentation to support its measurement of 
expected credit losses under FASB ASC Subtopic 326-20. That 
documentation should reflect the method(s) used to estimate expected 
credit losses for each portfolio segment.\31\
---------------------------------------------------------------------------

    \31\ See supra note 20.
---------------------------------------------------------------------------

    The staff normally would expect registrants to follow a systematic 
and consistently-applied approach to select the most appropriate 
expected credit loss measurement methods and support its conclusions 
and rationale with written documentation. Typically, registrants decide 
the methods to use based on many factors, which vary with their 
business strategies as well as their information system capabilities.
    As economic and other business conditions change, registrants often 
modify their business strategies, which may necessitate adjustments to 
the methods used to estimate expected credit losses. The staff normally 
would expect a registrant to maintain a process to evaluate whether 
adjustments to the methodology are necessary and, if so, maintain 
documentation to support adjustments to the methodology used.
    A registrant's methodology should produce an estimate that is 
consistent with GAAP. The staff normally would expect that, before 
employing an expected loss method, a registrant would evaluate and 
modify, as needed, the method's assumptions related to the current 
estimate of expected credit losses. Also, the staff expects that 
registrants would typically document the evaluation, the conclusions 
regarding the appropriateness of estimating expected credit losses with 
that method, and the objective support for adjustments to the method or 
its results.
    A registrant shall measure expected credit losses on a collective 
(pool) basis when similar risk characteristic(s) exist.\32\ The staff 
normally would expect a registrant to maintain documentation to support 
its conclusion that the loans in each pool have similar 
characteristics.
---------------------------------------------------------------------------

    \32\ See ASC paragraph 326-20-30-2. Also refer to ASC paragraph 
326-20-55-5 for a list of risk characteristics that may be 
applicable.
---------------------------------------------------------------------------

    One method of estimating expected credit losses for a pool of loans 
is through the application of loss rates to the pool's aggregate loan 
balances.\33\ Such loss rates should generally reflect the registrant's 
historical credit loss experience consistent with the remaining 
contractual terms \34\ for each pool of loans, adjusted to reflect the 
extent to which management expects current conditions and reasonable 
and supportable forecasts to differ from the conditions that existed 
for the period over which historical information was evaluated.\35\
---------------------------------------------------------------------------

    \33\ See ASC paragraph 326-20-55-18 through 326-20-55-22 for an 
example illustrating one way an entity may estimate expected credit 
losses on a portfolio of loans with similar risk characteristics 
using a loss-rate approach.
    \34\ See ASC paragraph 326-20-30-6 for guidance on determining 
the contractual term.
    \35\ See ASC paragraph 326-20-30-9 for guidance related to 
adjusting historical loss information.
---------------------------------------------------------------------------

    If a registrant utilizes external data, the staff normally would 
expect that the registrant would demonstrate in its documentation the 
relevance and reliability of the external data. The registrant should 
consider whether the external loss experience data comes from loans 
with credit attributes similar to those of the loans included in the 
registrant's portfolio and is consistent with the registrant's 
assumptions regarding current and forecasted

[[Page 64737]]

economic conditions.\36\ The staff normally would expect a registrant 
to maintain supporting documentation for assumptions and data used to 
develop its loss rates, including its evaluation of the relevance and 
reliability of any external data.
---------------------------------------------------------------------------

    \36\ See ASC paragraph 326-20-30-8.
---------------------------------------------------------------------------

    If a registrant uses the present value of expected future cash 
flows to measure expected credit losses,\37\ the staff normally would 
expect supporting documentation for the assumptions and data used to 
develop the amount and timing of expected cash flows and the effective 
interest rate used to discount expected cash flows.
---------------------------------------------------------------------------

    \37\ See ASC paragraph 326-20-30-4.
---------------------------------------------------------------------------

    If a registrant uses the fair value of collateral to measure 
expected credit losses, the staff normally would expect the registrant 
to document:
     The basis for its conclusion that the loan qualifies under 
GAAP for measurement of expected credit losses based on the fair value 
of the collateral; \38\
---------------------------------------------------------------------------

    \38\ See ASC paragraph 326-20-35-4 through 326-20-35-6 for 
guidance regarding when it is appropriate to measure expected credit 
losses based on the fair value of the collateral as of the reporting 
date.
---------------------------------------------------------------------------

     How it determined the fair value of the collateral, 
including policies relating to the use of appraisals, valuation 
assumptions and calculations, the supporting rationale for adjustments 
to appraised values, if any, and the determination of costs to sell, if 
applicable; and
     The recency and reliability of the appraisal or other 
valuation.
    Regardless of the method used, the underlying assumptions used by 
registrants to develop expected credit loss measurements should 
consider current conditions and reasonable and supportable forecasts. 
The staff normally would expect a registrant to document the factors 
used in the development of the assumptions and how those factors 
affected the expected credit loss measurements.\39\ Factors to be 
considered include the following:
---------------------------------------------------------------------------

    \39\ See ASC paragraph 326-20-55-4 for examples of factors to 
consider.
---------------------------------------------------------------------------

     Levels of and trends in delinquencies and performance of 
loans;
     Levels of and trends in write-offs and recoveries 
collected;
     Trends in volume and terms of loans;
     Effects of any changes in reasonable and supportable 
economic forecasts;
     Effects of any changes in risk selection and underwriting 
standards, and other changes in lending policies, procedures, and 
practices;
     Experience, ability, and depth of lending management and 
other relevant staff;
     Available relevant information sources that support or 
contradict the registrant's own forecast;
     Effects of changes in prepayment expectations or other 
factors affecting assessments of loan contractual term;
     Industry conditions; and
     Effects of changes in credit concentrations.
    Factors affecting collectibility that are not reflected in the 
registrant's historical loss information should be evaluated to 
determine whether an adjustment is necessary so that the expected 
credit loss measurement considers those factors.\40\ For any adjustment 
of loss measurements based on current conditions and reasonable and 
supportable forecasts, the staff normally would expect a registrant to 
maintain sufficient evidence to (a) support the amount of the 
adjustment and (b) explain why the adjustment is necessary to reflect 
current conditions and reasonable and supportable forecasts in the 
expected credit loss measurements. Supporting documentation for 
adjustments may include relevant economic reports, economic data, and 
information from individual borrowers.
---------------------------------------------------------------------------

    \40\ See ASC paragraph 326-20-30-9 for guidance on when it is 
not appropriate to make adjustments to historical loss information 
for forecasted economic conditions.
---------------------------------------------------------------------------

    The staff normally would expect that, as part of the registrant's 
allowance for credit losses methodology, it would create a summary of 
the amount and rationale for the adjustment factor for review by 
management prior to the issuance of the financial statements. The staff 
normally would expect the nature of the adjustments, how they were 
measured or determined, and the underlying rationale for making the 
changes to the allowance for credit losses balance to be documented. 
The staff also normally would expect appropriate documentation of the 
adjustments to be provided to management for review of the final 
allowance for credit losses amount to be reported in the financial 
statements.
    Similarly, the staff normally would expect that registrants would 
maintain documentation to support the identified range and the 
rationale used for determining which estimate is the best estimate 
within the range of expected credit losses and that this documentation 
would also be made available to the registrant's independent 
accountants. If changes frequently occur during management or credit 
committee reviews of the allowance for credit losses, management may 
find it appropriate to analyze the reasons for the frequent changes and 
to reassess the methodology the registrant uses.
    Facts: Registrant H has completed its estimation of its allowance 
for credit losses for the current reporting period, in accordance with 
GAAP, using its established systematic methodology.
    Question 6: What summary documentation would the staff normally 
expect Registrant H to prepare to support the amount of its allowance 
for credit losses to be reported in its financial statements?
    Interpretive Response: The staff normally would expect that, to 
verify that the allowance for credit losses balances are presented 
fairly in accordance with GAAP and are auditable, management would 
prepare a document that summarizes the amount to be reported in the 
financial statements for the allowance for credit losses,\41\ and that 
such documentation also include sufficient evidence to support the 
allowance and internal controls over the allowance. Common elements 
that the staff normally would expect to find documented in allowance 
for credit losses summaries include:
---------------------------------------------------------------------------

    \41\ See supra note 16.
---------------------------------------------------------------------------

     The reasonable and supportable economic forecasts used;
     The estimate of the expected credit losses using the 
registrant's methodology or methodologies;
     A summary of the current allowance for credit losses 
balance;
     The amount, if any, by which the allowance for credit 
losses balance is to be adjusted; and
     Depending on the level of detail that supports the 
allowance for credit losses analysis, detailed subschedules of loss 
estimates that reconcile to the summary schedule.
    Generally, a registrant's review and approval process for the 
allowance for credit losses relies upon the data provided in these 
consolidated summaries. There may be instances in which individuals or 
committees that review the allowance for credit losses methodology and 
resulting allowance balance identify adjustments that need to be made 
to the loss estimates to provide a better estimate of expected credit 
losses. These changes may occur as a result of holistically evaluating 
the individual components of the estimation process and considering the 
overall estimate of the allowance for credit losses as a whole or due 
to information not known at the time of the initial loss estimate. It 
would be important that these adjustments be consistent with GAAP and 
be reviewed

[[Page 64738]]

and approved by appropriate personnel. Additionally, it would typically 
be appropriate for the summary to provide each subsequent reviewer with 
an understanding of the support behind these adjustments. Therefore, 
the staff normally would expect management to document the nature of 
any adjustments and the underlying rationale for making the changes.
    The staff also normally would expect this documentation to be 
provided to those among management making the final determination of 
the allowance for credit losses amount.
4. Validating a Systematic Methodology
    Question 7: What is the staff's guidance to a registrant on 
validating, and documenting the validation of, its systematic 
methodology used to estimate allowance for credit losses?
    Interpretive Response: The staff believes that a registrant's 
allowance for credit losses methodology is considered reasonable when 
it results in a valuation account that adjusts the net amount of its 
existing portfolio to cash flows expected to be collected.\42\
---------------------------------------------------------------------------

    \42\ See ASC paragraph 326-20-30-1.
---------------------------------------------------------------------------

    The staff normally would expect the registrant's systematic 
methodology to include procedures to assess the continued relevance and 
reliability of methods, data, and assumptions used to estimate expected 
cash flows.
    To verify that the allowance for credit losses methodology is 
reasonable and conforms to GAAP, the staff believes it would be 
appropriate for management to establish internal control policies, 
appropriate for the size of the registrant and the type and complexity 
of its loan products and modeling methods.
    These policies may include procedures for a review, by a party who 
is independent of the allowance for expected credit losses estimation 
process, of the allowance methodology and its application in order to 
confirm its effectiveness.
    While registrants may employ many different procedures when 
assessing the reasonableness of the design and performance of its 
allowance for credit losses methodology and appropriateness of the data 
and assumptions used, the procedures should allow management to 
determine whether there may be deficiencies in its overall methodology. 
Examples of procedures may include:
     A review of how management's prior assumptions (including 
expectations regarding loan delinquencies, troubled debt 
restructurings, write-offs, and recoveries) have compared to actual 
loan performance;
     A review of the allowance for credit losses process by a 
party that is independent and possesses competencies on the subject 
matter. This often involves the independent party reviewing, on a test 
basis, source documents and underlying data and assumptions to 
determine that the established methodology develops reasonable loss 
estimates;
     A retrospective analysis of whether the models used 
performed in a manner consistent with the intended purpose of 
developing an estimate of expected credit losses; and
     When the fair value of collateral is used, an evaluation 
of the appraisal process of the underlying collateral. This may be 
accomplished by periodically comparing the appraised value to the 
actual sales price on selected properties sold.
    The staff believes that management should support its validation 
process with documentation of the specific validation procedures 
performed, including any findings of an independent reviewer. The staff 
normally would expect that, if the methodology is changed based upon 
the findings of the validation process, documentation that describes 
and supports the changes would be maintained.
    The staff encourages anyone with questions or suggestions regarding 
this interpretation to contact the staff via email at [email protected] or 
phone at (202) 551-5300.

[FR Doc. 2019-25450 Filed 11-22-19; 8:45 am]
BILLING CODE 8011-01-P