Since the effective date of ASC 326 (CECL), we’ve been asked several questions regarding the need for a separate liability for off-balance sheet (OBS) credit exposures, or an “unfunded commitments liability”.
Several factors should be considered when determining if this is necessary for your financial institution. Here are three essential steps to guide your decision:
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Gather data on any potential OBS credit exposures the bank might have entered into. Those include:
- Commitments to extend credit (but have not yet funded),
- Guarantees, and
- Standby letters of credit.
These types of commitments should be analyzed for potential future credit losses as long as they are not also accounted for as insurance contracts, derivatives, or the fair value option has not been elected.
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Analyze the credit exposures to determine if they are unconditionally cancellable.
In other words, can the bank cancel the commitment at any time, with full discretion (i.e., for no specific reason or condition being met)?
It’s important to read the language in the commitment agreements in order to determine if the bank has this right. If that is the case, then these types of commitments are excluded from the standard and do not need a separate liability booked.
*Note – HELOC’s require special consideration given they fall under Regulation Z. Regulation Z has requirements related to the bank’s ability to cancel the line of credit.
If the credit exposures are not unconditionally cancellable, then they will need to be analyzed for future potential losses. It’s important to categorize (or pool) these commitments in a similar manner as the on-balance sheet commitments are for CECL.
If the bank uses call report codes to pool loans for the allowance for credits losses (ACL) account, then those same pools should be used for the OBS credit exposures. However, if there is an OBS credit exposure that does not have the same risk characteristics as the other commitments in that pool, they should be individually analyzed.
Once the OBS credit exposures have been segregated into pools, each pool should be analyzed for the likelihood of funding and the amount of potential funding for the remaining life of the commitment. This is why it is important to categorize these commitments into pools.
For example, a HELOC might have a different funding rate than a commercial line of credit. Additionally, a commercial line of credit might also have a life term than a HELOC. Thus, it’s important to consider the funding likelihood for each pool. We have suggested that banks reach out to their core provider to help them obtain reports in order to determine the likelihood of funding.
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Analyze the commitments for estimated future credit losses after they have been pooled and a funding rate applied.
That amount should then be booked as a separate liability and should not be included in the contra-asset ACL account. This is in accordance with ASC 326. It is recommended that this analysis be completed each time the bank analyzes credit losses for the contra-asset account.
If you or anyone at your bank has questions regarding OBS credit exposures, reach out to our team of financial institution advisors.
