CREDIT LOSSES
12D. ACL
Bank Accounting Advisory Series
273
August 2018
Early adopters only
Staff Response
Yes. The net charge-off on the classified loan that was removed from the pool of pass-rated
loans should be included in the historical lifetime loss rate applied to the pool of pass-rated
loans. Although the net charge-off on the classified loan is included in the historical lifetime
loss rate applied to the group of pass-rated loans, the classified loan balance is no longer
included in the pass-rated pool for purposes of calculating the ACL.
Facts
A bank has historical loss data that include multiple economic cycles. The data also
cover a period of time in excess of the contractual term of its entire loan portfolio. The data
show that the bank has experienced a very low level of credit losses. The characteristics of the
bank’s current portfolio are similar to the characteristics of the portfolios that generated the
historical loss data.
Question 7
Does the bank need to supplement its historical loss experience with external (i.e., peer or
market) data when determining its ACL?
Staff Response
No. A low level of credit losses over an extended time period is not, by itself, a condition that
would necessitate a bank defaulting to, or supplementing its loss experience with, external
data. The bank may have a sufficient loss history to use its own experience as a starting point
for its ACL, even though its credit losses have been minimal.
In this fact pattern, the bank compared the characteristics of its current loan portfolio with the
portfolio characteristics that generated its historical loss data. Because the nature, terms,
volume, and underwriting standards of the current portfolio, as well as the bank’s expectations
about future economic conditions, were similar to the portfolios and economic conditions that
generated the loss experience, the bank will not need to supplement its historical loss
experience with external data.
Conversely, if the characteristics of the current portfolio or the bank’s expectations about
future economic conditions had differed significantly from the portfolios and economic
conditions that generated the loss experience, the bank would need to consider whether the use
of external data, or appropriately supported qualitative adjustments to its own data, is
necessary to appropriately reflect the bank’s expected credit losses.
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CREDIT LOSSES
12D. ACL
Bank Accounting Advisory Series
274
August 2018
Early adopters only
Facts
Assume the same facts as in question 7, except the bank’s historical loss data cover
only the most recent five years. The most recent five years did not include a full economic
cycle. Additionally, the remaining contractual term of the bank’s portfolio exceeds five years.
Question 8
Should the bank supplement its historical loss experience with external (i.e., peer or market)
data or qualitative factors when determining its ACL?
Staff Response
Yes. The bank would likely need to obtain external loss data, or employ qualitative factors, to
estimate the expected credit losses that will occur subsequent to the five-year period covered
by the loss history, but prior to the end of the portfolio’s contractual term. Although the bank’s
historical credit loss experience may be used as a starting point for estimating expected credit
losses, the most recent five-year period of loss experience is not, by itself, a sufficient basis to
determine the ACL, as the length of time covered by the historical loss information is not
reflective of the remaining contractual term of the portfolio.
Because the contractual term of the bank’s portfolio exceeds the time period covered by the
bank’s historical loss experience, the bank likely does not have sufficient internal data to
estimate lifetime expected credit losses.
Additionally, the bank will need to consider whether current and forecasted economic
conditions are consistent with the economic conditions that generated the historical loss
experience. If current or forecasted economic conditions differ from the conditions covered by
the bank’s historical loss experience, adjustments to the bank’s historical loss experience will
need to be made to account for the change that these conditions are expected to have on the
expected credit losses. These adjustments can be made by supplementing the bank’s historical
loss data with external data or by applying appropriately supported qualitative adjustments.
Question 9
Will a bank be subject to criticism if its methodology is inappropriate but its ACL balance is
appropriate?
Staff Response
Yes. The OCC emphasizes an ACL evaluation process that is safe, sound, comprehensive,
well documented, consistently applied, and compliant with GAAP. Even if the examination
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CREDIT LOSSES
12D. ACL
Bank Accounting Advisory Series
275
August 2018
Early adopters only
team determines a bank’s current ACL balance is appropriate for the bank’s loan portfolio and
level of credit risk, but management does not have a sound basis for determining an
appropriate level for the ACL on an ongoing basis, the process would be considered deficient.
Facts
At origination, the bank requires a borrower to obtain PMI on a SFR mortgage that
names the bank as loss payee. The cost of the PMI is included in the borrower’s monthly loan
payment, similar to property taxes and insurance. The PMI covers losses on the loan regardless
of who owns the loan (e.g., if the loan is sold, any PMI benefits belong to the new owner of
the loan).
Question 10
Should the bank consider the borrower-paid, individual PMI when determining the ACL?
Staff Response
Yes. Individual loan PMI that is legally attached to the mortgage loan and not separately
exercisable, regardless of who owns the loan, should be considered in determining the bank’s
ACL. In determining the PMI’s effect on the ACL, the bank must assess the insurer’s
willingness and ability to repay the loan in the event of the borrower’s default. For example,
the bank must analyze the insurer’s history and timeliness for paying claims and the insurer’s
financial condition. If evidence suggests the bank may not be able to fully recover claims
submitted to the insurer or would require legal action to enforce the contract, the bank should
make adjustments to reflect that evidence when determining an appropriate ACL. For further
discussion of accounting for mortgage insurance receivables, see Topic 5A, questions 31–32.
Question 11
Would the staff response to question 10 be different if the bank obtained mortgage insurance
on a pool of loans, rather than borrower-paid PMI, and a loan would no longer be covered
under the bank’s insurance policy if sold to another institution?
Staff Response
Yes, because the characteristics of the mortgage insurance in question 11 are different from
the mortgage insurance described in question 10. The mortgage insurance described in
question 11 is legally detachable from the mortgage loans and is a separate freestanding
contract that serves to mitigate credit losses on the pool. ASC 326-20-30-12 does not allow a
bank to consider freestanding contracts when estimating the ACL.
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