By Amy Leisinger, J.D.
The SEC staff has published a new staff accounting bulletin to update existing guidance with respect to methodologies and supporting documentation for measuring and accounting for loan losses. In the bulletin, the staff discusses the documentation that it would normally expect registrants engaged in lending transactions to prepare and maintain to support estimates of expected credit losses for loan transactions.
Measuring losses. According to the staff, at each reporting date, an entity should record an allowance for credit losses on assets measured on an amortized cost basis and a liability for credit losses on certain off-balance-sheet exposures. The allowance for credit losses is an estimate of current expected credit losses considering available information relevant to assessing the collectability of cash flows, the bulletin notes. In establishing the estimate, a registrant should consider historical experience, current conditions, and reasonable forecasts that affect collectability, according to the staff.
Systematic methodology. The staff states that a registrant should have a systematic methodology to determine its provision and allowance for credit losses. The allowance methodology should be influenced by specific factors relevant to the entity, including organizational structure, strategies, risk assessments, and loan portfolio complexity. However, according to the bulletin, each registrant should have a methodology that, among other things: (1) identifies relevant risks; (2) involves consideration relevant data; (3) addresses expected credit losses of all existing loans and measures them in a pool when similar risk characteristics are involved; and (4) includes a logical means to consolidate loss estimates so that the allowance for credit losses can be recorded in accordance with GAAP. Management should periodically review the propriety of methodologies, the staff explains.
Policies and procedures. Further, the staff notes that registrants use variety of policies, procedures, and control systems tailored to their own businesses. However, the staff believes that, for an allowance methodology to be effective, a registrant’s policies and procedures to maintain an appropriate allowance for credit losses should likely address: (1) the responsibilities of the personnel that determine the allowance; (2) the methods used in developing the allowance; (3) a description of the systematic methodology; and (4) how internal controls ensure that the allowance is in accordance with GAAP. The bulletin also notes that a registrant’s policies and procedures should describe the approach used to pool loans based on similar risk characteristics, methods used to determine the contractual terms of financial assets, and the means by which historical data and historical credit loss information is used, among other things.
Documentation. The staff also expects a registrant to maintain documentation to support its measurement of expected credit losses and to demonstrate that the loss measurement methods and assumptions used to estimate the allowance are determined in accordance with GAAP. According to the bulletin, a registrant also should demonstrate in documentation the relevance and reliability of data in making its determinations. The staff also notes that allowance-for-credit-losses summaries should include the economic forecasts used, the estimate of the expected losses, and a summary of the current allowance for credit losses balance.
Validation. The staff expects a registrant’s systematic methodology to include procedures to assess the continued reliability of the methods, data, and assumptions used to make estimations. To verify conformance to GAAP, the bulletin suggests that it would be appropriate for management to establish internal control policies, which may call for independent review. The staff also states that management should support its validation process with documentation of the specific procedures performed and any changes made as a result of the process.