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. 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 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.

On November 15, 2019, the FASB delayed the effective date of the standard 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 accounting bulletin should be read to accelerate or delay the effective dates of the standard as modified by the FASB.

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

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

PART 211—INTERPRETATIONS RELATING TO FINANCIAL REPORTING MATTERS

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).

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

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.

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.

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.

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).

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).

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.

This staff guidance is applicable upon a registrant's adoption of FASB ASC Topic 326. 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 will no longer be applicable.

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 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, there are certain common elements that the staff would expect in any methodology:

• Identify relevant risk characteristics and pool loans on the basis of similar risk characteristics;

• Consider available information relevant to assessing the collectibility of cash flows;

• Consider expected credit losses over the contractual term 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;

• 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. 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.

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 for the allowance for credit losses estimation process to:

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

• 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.

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;
• 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:

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

• 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;

• 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;

• The method for estimating expected recoveries when measuring the allowance for credit losses;

• 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;

• 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; and

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

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.

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. The staff normally would expect a registrant to maintain documentation to support its conclusion that the loans in each pool have similar characteristics.

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. Such loss rates should generally reflect the registrant's historical credit loss experience consistent with the remaining contractual terms 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.

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 economic conditions. 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.

If a registrant uses the present value of expected future cash flows to measure expected credit losses, 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.

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;

• 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. Factors to be considered include the following:

• 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. 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.

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, 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:

• 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 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.

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 OCA@sec.gov or phone at (202) 551-5300.